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COPYRIGHT DEPOSE.

Appletons' Business Series

INTRODUCTION TO FINANCE — DESCRIBING THE METHODS, INSTRUMENTS, AND INSTITU- TIONS OF MODERN FINANCIAL TRANSACTIONS

BY FREDERICK A. CLEVELAND, Ph.D., LL.D.

FORMERLY PROFESSOR OF FINANCE, NEW YORK UNIVERSITY SCHOOL OF

COMMERCE ACCOUNTS AND FINANCE; PROFESSOR OF U. S. CITIZENSHIP

ON THE MAXWELL FOUNDATION, BOSTON UNIVERSITY

REVISED EDITION, ENLARGED AND EDITED BY HENRY B. HALL, Ph.D.,

FORMERLY ASSOCIATE PROFESSOR OF MONEY AND BANKING, WESLEYAN UNIVERSITY; ECONOMIST FOR THE STATE OF RHODE ISLAND

D. APPLETON AND COMPANY NEW YORK : : 1922 : : LONDON copyright, 1902, 1903, 1922 BY D. APPLETON AND COMPANY

PRINTED IN THE UNITED STATES OF AMERICA

DEC -5

EDITOR'S FOREWORD

The wide recognition as a standard text accorded Professor Cleveland's Funds and Their Uses during the last two decades makes the work of revising it a privilege as well as a duty. Some features of the book deserve special notice. The practical point of view maintained throughout is one of these features; the subjects are presented as matters of actual occurrence, so that the reader is not detained in mere theorizing, but rather he is led simply and directly to an intimate and accurate knowledge of the financial instruments and institutions of modern business. At the outset, the title is explained; the term "funds" as used in the text has much the same meaning as ' ' cash, ' ' but includes more — ' ' any and all things which may be accumulated and which may be currently used in a community in exchange for goods or properties." Money and credit are treated as two different classes of "funds." Money is a form of funds which, when exchanged, completes the transaction ; while credit is a form of funds which, when received in exchange or payment, is valued as a promise to deliver money in the future.

Part I deals with our money system ; following which it is pointed out that in most purchases and sales credit instead of money is used. But how and why this occurs is explained in Parts II and III, which deal respectively with credit instruments and credit institutions.

In actual business practice funds are usually obtained by first having possessed one's self of something to sell — goods or services; although they may be obtained by gift or by inheritance. Since the business man and banker usually obtain their funds by disposing of goods, they are chiefly vi EDITOR'S FOREWORD

concerned with questions of relative value of things offered. In this relation distinction is made between forms of credit used to obtain funds and forms of credit used as cash. Again, in describing the several forms of credit used for obtaining funds, distinction is made between commercial paper as a form employed to obtain funds for current use, and corporate securities as instruments employed to obtain funds for more permanent use. The line drawn between these two classes of instruments is that commonly recognized in everyday business experience.

The student 's interest is aroused by the business problems presented and then he is led to acquire knowledge of the specific instruments used. The same policy is pursued throughout the book. Part III opens with the money and credit functions of the United States Treasury. Chapters dealing with commercial banking emphasize the problems which concern the bank manager rather than questions of academic interest. In these are included the national bank, the state bank and the private bank as related parts of a common credit service. The federal reserve system is outlined from this same practical point of view. What was it devised for? What does it do? How does it supplement the work done by other institutions? Minor details of organization, though mentioned, are relegated to their proper place in the discussion. The chapters on insurance companies, building loan, cooperative loan and investment institutions, investment bankers, brokers and broker's boards add still further to the completeness and practicability of the book.

The book is well supplied with illustrative material. There are over a hundred and thirty-five illustrations showing differing kinds of ' money ; forms of credit for cash ; notes, drafts, invoices and bills of exchange ; stock certificates and bonds; as well as interior and exterior pictures of important banking and other characteristic

EDITOR'S FOREWORD vii

institutions. These illustrations are even more instructive than any description in the text could possibly be. For example, the foreign bill of exchange ; the grain warehouse receipt or the order bill of lading can be much more thoroughly comprehended by the student unfamiliar with business documents if they are shown to him in sample, than if they are merely described. The student who can actually have under his eye fac-similes of these instruments of credit, see what they look like and what they have written upon them, will find therein instruction which no amount of exposition could ever give to him.

The classification of subject material is effective. It follows the natural human inquisitive bent by asking the questions in succession — What? How"? Who? What are funds, that is to say, what are the things with which the great business world makes its yearly payments of billions of dollars ? How are these things obtained ? What is their source and in what manner are they related to the operations of production, transportation, storage and exchange? Who handles these things, individuals, private corporations, government agents? What is the relation between these institutions, and what are the methods and systems under which they operate?

This is the general trend of the subject matter of the book. It follows the lines of approach and investigation which have repeatedly proved successful in presenting courses in money and banking to classes in business colleges, as well as in colleges of liberal arts.

The present edition has been thoroughly revised and rewritten where necessary to bring it up-to-date. It has also been considerably enlarged. The chapters on the United States Treasury, commercial banks, Federal Reserve System, trust companies, investment banker, and agricultural credit institutions are virtually new. They have been written primarily to meet the needs of college viii EDITOR'S FOREWORD

classes in approaching for the first time the problems of money, banking, and special courses in public and private finance. Each chapter is followed by a short bibliography to be used for collateral readings.

Henry B. Hall

North Pemberton, Mass.

Author's Preface To Revised Edition

Except in its public aspects, the subject of finance had received little attention in the schools and at the hands of writers of books before 1901 when the first edition of this modest volume was prepared. The necessity for funds with which to carry on King William's war with France gave rise to the Bank of England, and with it to modern funding methods. Nearly all the great banks founded before the latter half of the nineteenth century and all the great banking systems had grown out of public rather than private needs. So constantly had attention been drawn to funding measures of government that the words "finance" and "funds" had come to be associated almost exclusively with public affairs.

About the time of the Civil War the world entered upon a new era— an era marked by rapidly increasing cumulations of investment funds in the hands of privately managed institutions of saving and insurance. And, coincident with this centralization of investment capital, private corporate organizations rapidly expanded. Then followed the period of "consolidations," "holding-companies," "trusts," the "billion dollar industries." New problems were presented, which required of the student of finance that he have an understanding of the methods, instruments and institutions of private as well as of public funding. And a new literature of finance came into being. It was to bring together and present in simplest form the elementary facts related to both branches of the science that this book was written.

ix x AUTHOR'S PREFACE TO REVISED EDITION

In twenty years the institutions of finance have undergone great change. It was necessary therefore to have the book revised and enlarged, especially Part III. This has been chiefly the work of the editor, Professor Henry B. Hall. To the collaborators — to Professor Robert H. Loomis of Boston University College of Business Administration — for advice and cooperation in planning the revision and assistance in preparing the bibliography and writing the paragraphs on the Morris Plan banks, to Mr. Eugene Jay Koop of Spencer Trask & Co. for valuable assistance in preparing the chapter on "The Investment Banker" and for reviewing the chapter on ' ' The Broker and the Broker 's Board" and especially to Mr. Erastus W. Bulkley, who has shown interest in having the volume brought up to date and who has been generous in suggestions for revision as well as contributing materially to the chapter on ' ' The Investment Banker" and to Miss Edith A. Goodspeed for assistance in reading the manuscript and preparing the table of contents — the author desires to express grateful appreciation on behalf of himself and the editor.

Frederick A. Cleveland Norwood, Mass.

Contents

CHAPTER PAGE

I. Public and Private Funds 3-11

Property, 3. How property is acquired, 3, 4. Exchange the chief method of acquiring property, 4, 5. Importance of funds in business, 5. What is business, 5, 6. Necessity for law and order in business, 6, 7. Business law, 7, 8. Elements of success in business, 8-10. Funds a necessary part of business equipment, 10. Funds, the subject of finance, 10, 11.

Chapter I

Property. — Among the first ideas that one gets as a child is a notion of respect for the "property" of others; we soon come to know that there is a difference between those things which we may call "our own" and those things which "belong" to another. The teachings of parents first impress the lesson ; later, the idea becomes firmly fixed through association with playmates and elders. Any attempt to violate what are commonly recognized as ' ' rights of property" brings us quickly to grief. The jealousy with which the child guards his right to use his own top, his own marbles, his own knick-knacks, and the respect which he comes to have for things displayed in shop-windows or in the possession of his playmates, illustrate the force with which ideas of property are early impressed upon the race.

How property is acquired. — No sooner does the child come to know the use of things, or begin to long for objects that attract his notice, than he learns that the "consent" of some one must be obtained before they may be taken. From a parent, a sister, or a brother — a member of the household — this consent may be had for the asking ; within the family, acquisition takes the form of ' ' gift. ' ' In order to obtain things from others, however — those not bound by ties of affection or duty — a mere request is not enough. In front of a shop sits a basket of apples. It has been placed there by the owner, the shopkeeper, to attract attention. The rich color and fragrance of the fruit suggests to the passing child that he would like to have some of it ; and he seeks to obtain an apple ' ' by gift, " as he had been used to doing at home. But his request is refused. The mere request of the child is not enough to win the consent of the shopkeeper. How is he to obtain the coveted apple ? The shopkeeper helps him out of his trouble. "Have you a penny ? " ' ' No. " "If you will get me a penny I will let you have an apple." With this suggestion the boy gets his first idea in finance. He runs to his father; he gets a penny "by gift," and, returning gets an apple "by exchange." Thus he learns how the "consent" of shopkeepers may be won, and that there is a second method by which the property of others may be acquired.

Exchange the chief method of acquiring property. — Exchange lies at the foundation of the world 7 s industrial progress. The story of Crusoe serves well to illustrate the possibilities of life without it. This lonely man, cast ashore on an island, found useful things all around him. But they must be gathered, and they must be reshaped and put together in a different way than they were found in nature. Among a primitive people centuries may be required to obtain from nature the metals needed for a few rude weapons and tools. We have but to think of the many things about the modern household, each of which adds something to comfort or pleasure, to realize how incapable man would be if he had to make everything for himself.

How long, for example, would it take a man, working alone, to extract from the ore a pound of iron? Even if he found the metal, how long must be labor to make a needle or a screw ? Few of the common things in use to-day could be had at all ; they are each the product of the labor of many hands, working with different processes, in different places, each offering in exchange for things desired may say, inherited from a society that has labored for centuries past. Each thing that we use is the product of a great cooperative society, bound together in service by the instruments and institutions of exchange. Without exchange, cooperation would be impossible. In every instance, increased facilities afforded for exchange have led to a wider range of social and industrial activity. To its development we owe the economics made possible by division of labor, the benefits of the factory system, the larger returns made possible by mass production and by the direction and control of the enormous forces and resources of nature, which, when working alone, man has been unable to turn to his uses. Every milestone of human progress has engraved upon it the significant emblem ' ' Exchange. ' '

Importance of funds in business. — Out of exchange arises the need for "funds'' — stocks or stores of money or other things that can be used as means of purchase and payment. In business there is no word so big with meaning. " If I could get the necessary funds, ' 7 says the blacksmith, "I would build a wagon shop." The grocer does not add to his stock of sugar when the price is low "for lack of funds." "We are in need of funds," says the building contractor to his partner, "we must have at least $1,000 more to pay our men." "Our funds are running low," says the miller's clerk, "we must realize on outstanding bills, or make some other arrangement to meet obligations maturing on the first of the month. " It is out of just such situations and just such problems that the business of finance arises. ' ' Funds ' ' are the key to business under an economy of exchange — a necessary part of business equipment.

What is business? — John Ruskin calls business a game of counters. Business for profit is a contest in which everv one uses the same kind of counters — and is striving for the same thing. One has but to look out on Broadway or any busy street of a great city to be impressed with the fact that some kind of contest is going on. Men are hurrying to and fro, pushing each other about ; each is trying to get somewhere, to do something, one does not know why. But it is evident that each has something very definite in mind and that he is straining every nerve and muscle to accomplish a purpose. What is it that brings these crowds together, takes them to the shops, causes some to stand behind work benches and sweat before furnaces? Each seems to be working and striving in a different way, but if you ask the clerk or the f oundryman, the day -laborer or the banker, what he is striving for, each will make the same answer. And why? Each one has the same wants and desires to satisfy. What we call business is the effort of individuals and groups to possess themselves of things that are useful, either to themselves or others, in a peaceful way. And, in so far as they may not wish to use the things so obtained to satisfy their own wants, they seek to better their own condition by trading with others. The extent to which each betters his condition is called his ''gain" or "profit." The success of a business enterprise is measured by its "profits." The "profits" of a business, as business is now done, is the amount of the increase in the money value, of properties owned during a period for which the gains are reckoned.

Necessity for law and order in business. — In business there is the same need for rules that there is in any game or friendly contest. Every contest must have rules to govern it, for without rules there would be misunderstandings and these would lead to violence. Watch a group of boys at play. A number of marbles are placed within a ring ; a line is drawn, behind which each player must stand for the first throw ; the one who lands his marble nearest the center takes first shot. So the rules are laid down for the beginning of the game. After the contest is over each counts the marbles which he has driven out of the ring. Each player has put in two marbles as ' 'counters." At the end, one has scored three; he is one marble ahead, while the other player has driven out but one — he has lost a marble. There must be a rule for every possible situation and every point at issue, otherwise the game could not proceed. The one boy would not allow the other to take his marble (his property) unless he did it according to rules understood by both at the beginning. The same is true of football, baseball, lacrosse, every contest for points. Not only must the rules be known, but they must also be strictly observed. In case of a dispute as to what the rules are, or how they should be applied, the parties may come to a subsequent agreement, or, failing in this, they may refer the point at issue to some one not in the game who knows the rules. He who does not play "fair" may have some of his points taken away, or, on continued offense, may be "ruled out of the game. ' '

Business law. — In business the "counters" are money. Business law is nothing more nor less than the rules governing the contest. The honest man is the one who plays according to rule. A law-breaker not only runs the risk of losing points (i.e., of being "penalized") but he may be "ruled out." This may be done by his fellows' refusing longer to do business with him, or by his being "locked up," — put in jail as often as he breaks the rule. Business may be a very large game. The whole world is the field, and its rules must be understood and observed by all who come into common business relations. The laws of business must be common to all people trading together. It sometimes happens that those known as civilized people attempt to do business wtih others who do not understand their rules or who have different ones. This is like two sets of players entering a football contest, the one trying to play "association ball, ' ' and the other trying to play ' ' Rugby. ' ' Two systems of business come into conflict. The rules of the one people must be made to conform to those of the other or else there will be trouble. The common advantages of trade are so great that no one industrial group can afford to shut itself off. In fact, no barrier is strong enough to preclude men from following up a business advantage when it presents itself. This brings the people of all nations into constant contact. In the conflicts between systems, the stronger forces the weaker to change its rules. The importance of obedience to rules of business law is so great that nations as well as individuals are made to suffer by what is deemed a violation of them. That "honesty is the best policy" is a saying trite but true. Whatever may be said of the attitude of one nation toward another, no single individual can afford to raise even a suspicion of dishonest conduct, as this would cut him off from opportunity and preclude him from the advantages offered by broader cooperation with his fellows, cooperation made possible by confidence in fair dealing. To quote a saying of Mr. Croker, the old Democratic leader of New York: "No combination can be made where all are dishonest and each one knows it. The first element of leadership is honesty, perfect honesty. The honest man will prevail because other men will trust him. A rascal can trust an honest man, but a rascal can not trust a rascal. You may take one hundred men, ten of them honest and ninety of them false, and put them away on an island; come back in two months and, for the reasons I have given you, you will find the ten men dominating the rest. ' ' While Mr. Croker is not often referred to for standards of morality, his success as a politician has depended very largely upon his recognition of the advantage of strict integrity among his political followers, and the advantage of fair play is even more striking in business organization and control.

Elements of success in business. — In every game, two conditions are prerequisite to success: (1) An intimate knowledge of its rules; (2) Skill in the use of the instruments employed. In a game the success of which depends on teamwork, there is a third requisite — leadership. A knowledge of business laws, and skill in the use of the instruments and agents by means of which ''gains" are to be made, and leadership, are just as necessary to business success. Business is organized effort and requires able leadership, because of the ever-increasing breadth of competition that success brings. To the laborer — the one who relies for income on the sale of his labor, who subordinates his own business or talent to help another work out his schemes for gain — a general knowledge of law and of conditions existing outside the shop, in the market places and counting houses, may be of less importance than skill in the use of some particular tool ; but he must know enough of the rules to play his part well, otherwise he will not be able to render service to the manager to whom he engages himself. The man who is the head of a business organization, who manages a business plant and seeks income from the sale of its products must equip himself in a different way. He may have less skill in the use of some particular instrument than has any of the men whom he employs, but he must know the use of instruments, and know the manner in which they may be used by others to the highest advantage in order to equip the plant and working force, and provide the machinery of exchange and distribution in order to direct the efforts of those who look to him for leadership in such a manner as to make largest gains without breaking rules. Like a football captain, he must know how to manage his men and his plant so as to take advantage of every opening without being penalized for off-side plays and other infractions. Because business is cooperative, each person must be trained and equipped for whatever part he plays, and the leader must be able to think. in terms which will make him the master of every situation which presents itself.

Funds a necessary part of business equipment. — Business training, knowledge of the law, equipment adapted to the enterprise, materials, services, all are necessary, but in obtaining these the first need is for " funds. " The acquiring of funds, means of purchase and payment, therefore, may be said to be the first step in providing for business equipment and business success. The term " funds" is here used because there is no other in our language that is broad enough to convey the meaning. We cannot accurately use the words "money, " or "credit"; the common word which comes nearest to expressing the thought is "cash," and yet that has its limitations when considering capital funds. In this book therefore ' ' funds ' ' will be used as covering or including every form of means of purchase and payment.

Funds, the subject of finance. — Children are frequently found on the street asking for pennies. They have learned the use of money as a means of obtaining things desired, but they have not yet risen above the most primitive knowledge of how to get money. Their fathers and mothers may provide it by gift, as they would also provide the things which pennies will buy, but those not moved by affection or, as sometimes happens, by charity, turn a deaf ear to appeals of this kind. In early years, "gifts" based upon affection afford a means quite adequate, except in cases of inability of parents to provide. Generally speaking, girls and women throughout their lives are limited to this means of obtaining funds. Many men also pass their lives in this fashion — they obtain all things desired by means of funds contributed. Those who may not depend upon endowments of ancestors, and those engaged in active business, have quite different financial problems to solve. Finance is that branch of business which has to do with the getting and spending of funds necessary to the equipment and management of enterprise. A student of finance must first consider what is meant by "funds." When a business man says that "his funds are running low," what does he mean? Does he mean that his money is nearly all gone? Perhaps he has not had more than a dollar in his purse for a week, and has had no particular use for that, yet he has been carrying on a large "cash" business all the time— has had no lack of "funds." What are "funds"? How are they obtained? How are they managed? These three questions answered, the whole field of finance will have been covered.

Public finance is that science which deals with the getting and spending of funds for public uses, as for the maintenance and equipment and payment of the debts of the government ; private finance is that science which deals with the getting and spending of money for use in private business. This volume is intended to serve the purpose of leading the way into both branches — to give to the student a descriptive knowledge of the instruments and institutions by means of which funds are obtained and managed.

Carver, T. N., Principles of National Economy, Part I, Chapters vi, vii. (Ginn & Co., Boston, 1920.)

Cleveland, F. A., and Powell, F. W., Railroad Finance, Chapters i, ii, hi. (D. Applet on & Co., 1912.)

Hobson, J. A., Evolution of Modern Capitalism. (Chas. Scribner's Sons, New York, 1901.)

A good historical statement of the use of funds in early business development.

Mead, E. S., Corporation Finance. (D. Appleton & Co., New York, 1918.)

A recognized standard discussion of the elements of business enterprise.

Taussig, F. W., Principles of Economics, Vol. I, Book I, Chapters hi, v, vii. (Macmillan Co., revised, 1921.)

Chapter II

Experience will at once suggest that what we call ' ' funds ' ' must be something that will be accepted by others in exchange for their goods or services — i. e., something that others regard as valuable to them in their own business transactions. Those things which will serve as "funds" to one, must have such qualities that they will serve as "funds" to others. By way of illustration let us suppose that a blacksmith in Springfield wishes to enlarge his business. To that end he begins to accumulate a store of horseshoe nails. Each week he lays by twelve pounds of nails, until at last he has a ton of them. This might serve as "funds" in a community where every one desires horseshoe nails, but in Springfield not one in a thousand can make use of them. With this stock in hand he is not able to buy bricks, lime, or machinery, or pay for labor. Horseshoe nails are not "funds" in Springfield. The blacksmith, however, finds a man who can make use of a ton of nails; he exchanges them for ten double eagles of gold. He has sold his nails for no other purpose than to obtain something that will serve as funds. With $200 in gold he may purchase the materials and equipment desired. He has "funded" his enterprise.

Definitions — funds. — The whole system of finance grows out of the economy of exchange. Where commerce exists as a feature of business enterprise, where each member of a community strives to do that for which he is best fitted, and where each relies on exchange of things produced for other things desired, it is to the advantage of each to provide himself with "funds" with which purchases and payments may be made. A "fund" is a collection, or store, or amount of something by means of which purchases and payments may be made. The word "funds" signifies any and all things which may be accumulated and which may be currently used in a community in exchange for goods or properties of others. As has been suggested before, the consent of both parties is necessary to an exchange. That which will serve as funds must have qualities which will induce others to give their consent to part with the things which they own, in exchange. Funds that are collected or stored up to pay living expenses, or for the purchase of comforts and enjoyment, may be called "maintenance funds. ' ' They answer the same purpose for an individual that a fund would when laid by for the "maintenance" of a manufacturing plant. Funds that are collected or provided for business equipment are called "capital funds." The capital of a business concern is made up of funds contributed to it for permanent use. A money or a credit reserve laid by for the payment (sinking) of a debt is called a "sinking fund." When money is stored up for the purpose of hiding it away, and not for use, it is called a "safe deposit" or a "hoard." This, however, does not properly come within the field of finance. To "fund" an enterprise is to provide the means whereby such purchases and payments may be made as are necessary to its success. One whose business it is to provide funds for business enterprise is called a ' ' capitalist ' ' ; the manager of funds is a " financier " ; he who hoards money is a " miser. ' ' A "funded debt" is one for the payment of which some definite and adequate provision is made for funds when due. To illustrate: A borrows $1,000 from B. A thereby procures ' ' funds ' ' for his enterprise ; he funds his undertaking; he secures a working capital of $1,000. The instrument employed to this end is a contract for the future delivery of money which he sells to B for the funds desired.