what the nature of the
foreign exchange department's business really is.

1. _Selling "Demand" Against "Demand"_

The first and most elementary form of activity is, of course, the
buying of demand bills at a certain price and the selling of the
banker's own demand drafts against them at a higher price. A banker
finds, for instance, that he can buy John Smith & Co.'s sight draft for
L1,000, on London, at the rate of 4.86, and that he can sell his own
draft for L1,000 on his London banking correspondent at 4.87. All he
has to do, therefore, is to buy John Smith's draft for $4,860, send it
to London for credit of his account there, and then draw his own draft
for L1,000 on the newly created balance, selling it for $4,870. It cost
him $4,860 to buy the commercial draft, and he has sold his own draft
against it for $4,870. His gross profit on the transaction, therefore,
is $10.

As may be imagined, not very much money is made in transactions exactly
of this kind--the one cited is taken only because it illustrates the
principle. For whether the banker sends over in every mail a
bewildering assortment of every conceivable form of foreign exchange to
be credited to his account abroad, or whether he confines himself to
remittances of the simplest kinds of bills, the idea remains exactly
the same--he is depositing money to the credit of his account in order
that he may have a balance on which he can draw. That is, indeed, the
sum and substance of the exchange business of the foreign department of
most banking houses--the maintaining of deposit accounts in banks at
foreign centers on which deposit account the bank here is in a position
to draw according to the wants and needs of its customers.

To analyze the underlying transaction a little more closely, it is
evident that the banker, in order to make a profit, must be able to buy
the commercial bill at a lower rate of exchange than he can realize on
his own draft. Which suggests at once that the extent of the banker's
profit is dependent largely upon the amount of risk he is willing to
take. For the rate on commercial bills is purely a matter of the
drawer's credit. The best documentary commercial exchange, drawn at
sight on banks abroad or houses of the highest standing will command a
rate of exchange in the open market only a little less than the
banker's own draft. From which point the rate realizable on commercial
bills tapers off with the credit of the house in questio