Currency Exchange Rates: What Are They, How They Change, and More
Table of Contents
- What are Currency Exchange Rates?
- How to Calculate Exchange Rate?
- What Causes Exchange Rates to Change?
- How to Get the Best Exchange Rate?
If you are traveling abroad or planning on moving out of the country you will need to understand currency exchange rates. The majority of the time, individuals don't need to calculate currency cost, because there are remittance providers that will give them the rates available. However, it can be extremely useful to have an understanding of how currency exchange rates are calculated for your own personal knowledge and benefit.
What are Currency Exchange Rates?
Exchange rates are expressed as the value of one currency divided by the value of another. For example: USD/EUR refers to the conversion from US Dollars to Euros (If you are unfamiliar with which abbreviation is associated with each respective country's currency, there are currency acronyms and abbreviations tables available).
Now that you know what exchange rate definition is, its noteworthy to point out that you may come across various synonyms of a currency exchange rate; some of these are:-
- foreign exchange rate (also called FX rate)
- international exchange rate
- money exchange rate
- money transfer exchange rate
- remittance exchange rate
- (simply just) exchange rate
- (or even just) rates
Currency exchange rates have many names like foreign exchange rates, money transfer exchange rates, and so on.
Additionally, the term "exchange rate" also gets used in the various other contexts in combination with other words or phrases. So even though you may understand know what does exchange rate mean, it's always better to also know related terminology to have full knowledge on this important subject. Below, we provide examples of some such contextual usages of exchange rates.
- Since rates fluctuate dramatically every moment, it's important to look at exchange rate today. Naturally, anyone executing a foreign exchange transaction would want to know what is the current exchange rate.
- It is also useful to study rate changes over time, and the term historical exchange rates is used to signify the collected data of current and past rates.
- Money transfers are executed by money transfer operators that specialize in sending money overseas, so it's very common to use terms like Western Union exchange rate, MoneyGram exchange rate, and so on.
- With the advent of cryptocurrencies, it is no surprise that you will also come across terms like Bitcoin exchange rate or Ethereum exchange rate. This simply means the value of such cryptocurrencies in relation to a standard currency like the US Dollar.
Finally, there are also some types of exchange rates that you should be aware of. We mention these below.
What is mid-market exchange rate?
Also called interbank rate, a mid-market exchange rate is the rate used by international banks to move large sums of money between them. Typically, this is the highest possible rate available, and is generally not the rate that consumer or business money transfers get.
What is floating exchange rate?
A floating or an indicative exchange rate means that the rate quoted at the time of a transaction may not be the final rate applies when the transaction clears. The current rate at clearing time will be the rate used instead.
What is fixed exchange rate?
A fixed exchange rate is the exact opposite of a floating rate; this means that the quoted exchange rate will sustain all the way through to transaction clearing time.
There are pros and cons to evaluate when choosing between floating or fixed exchange rates. You should evaluate various factors to decide the most suitable one for your transaction.
How to Calculate Exchange Rate?
It's important to note that the order in which the currencies are placed in the equation does matter. To elaborate, USD/MXN refers to the exchange rate of US Dollar to Mexican Peso, or exchange rate of USD to MXN. On the other hand, MXN/USD refers to the opposite.
A currency's exchange rate is the quotient found by dividing the value of one currency by the other.
Understanding these rates opens up the ability to budget and calculate how much of one currency you will need to exchange for another when traveling or moving to another country.
Let's assume that you are going to Fiji for the summer and you currently reside in the United States. You are going to need to compare the value of US dollars to Fijian dollars. The equation will follow as such:
Although currency exchange rates are calculated through an equation, that equation (and the numbers involved) are provided by analysts and third-party providers. Ultimately, the equation creates a ratio that compares 1 to x. To elaborate, 1 unit of currency equals "x" of another currency. Suppose that the market price says that the exchange rate for the equation listed above comes out to 2.1867. This means that 2.1867 Fijian dollars (FJD) equate to 1 US dollar.
Once you have obtained the rate that is determined by global forces, you have the ratio that will facilitate other useful equations. For example, let's assume that you need about 4,000 US dollars to cover the summer of expenses in Fijian dollars. The equation works out to:
Even though the exchange rate, according to the market, comes out to 2.1867 FJD, a bank may charge you at an exchange rate of 2.30 for the conversion service. This is called an "FX Markup". In this case, the markup is 0.1133. The equation for this is:
Understanding the markup is useful for determining the best exchange service provider and getting the most out of your money when exchanging currency.
What Causes Exchange Rates to Change?
Currency rates fluctuate constantly. A country's currency value depends largely on what is happening within that specific country, and there are four main intrinsic factors that can contribute to these changes.
Interest Rates
Interest rates influence a variety of economic indicators; the currency exchange rate included. Interest rates are the percentages of principles that are charged by loan issuers in order for individuals to borrow money. Interest rates that affect currency exchange rates are determined by a country's central bank. The U.S. Central Bank is also known as the Federal Reserve. The higher that a federal interest rate is, the higher the currency value is, because high interest rates promise high returns for investors. Think of currency exchange as an investment in the currency.
Money Supply
Money supply, or the money that is in circulation, also affects the rate at which currency is exchanged from country to country. When there is too much money in production, hyperinflation is likely imminent. The government is also responsible for printing enough currency to provide for the demand. This includes a demand that satisfies both domestic users and foreign exchangers with their respective demands. Broadly, if there is too much or not enough money in circulation, individual units can decrease in value.
National Economy
The state of a country's economy is a good indicator of currency value. Stability, as well as growth within an economy, can help convince investors that their investment in a particular currency is a safe, smart choice. This leads to an increased value respective to different currencies.
If a country has no expected growth or is considered unstable, investors will probably be less likely to invest in that particular country because they want guaranteed (or as close to guaranteed as possible) returns on investments.
Remit Service Provider
Exchange rates will also vary depending on who is performing the remittance. A company will estimate the rate of exchange in a way they deem "fair" through a variety of factors (i.e. competitors, currency trends, remittance fees, etc.) These factors and fees associated vary from provider to provider.
All the above factors, thus, help explain how do exchange rates work. A healthy and vibrant economy will always have good, stable exchange rates that facilitate stable movement of money between countries.
How to Get the Best Exchange Rate?
There are a lot of factors involved in selecting the best exchange rates for sending money overseas. One sure way to reduce manual work is to rely on RemitFinder's comparison engine to ensure you save the most on your next money transfer. Use our exchange rate calculator by punching in your country combo and the amount you want to send, and easily compare various options to get the best currency exchange rate.
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