Exchange rates are important to both travelers and international investors. It's pretty easy to find exchange rate quotes these days, but you still need to know how to read them and make calculations based on them. In this article, we will take a closer look at currency exchange rates.
Finding and Reading Exchange Rates
You can find exchange rates in a number of different places, ranging from banks to websites like XE.com. If you're traveling, you can often find rates posted at airports or local banks. If you're trading in the foreign exchange ("forex") market, look at your trading platform for real-time information.
Quotes themselves are always given in pairs since currency values are always relative to one another. Not surprisingly, the U.S. dollar and euro are the two most commonly quoted currencies due to their status as reserve currencies at many global central banks. The most popular currency pair is, therefore, the EUR/USD, which is the number of dollars needed to purchase one euro.
These currency pairs fluctuate all the time due to various economic factors, including supply and demand, different economic indicators, commercial and hedging activity, and hedge fund or financial trading. The changes amount to just fractions of a currency's value, known as "pips" among currency traders.
It's also worth noting that many airport currency exchanges make money by charging a wider spread between the currencies. They don't charge an outright fee, but they make money by exaggerating the exchange rate differences. You can often get the best deal by exchanging currencies through your local or foreign bank.
How To Calculate Exchange Rates
Calculating exchange rates may seem simple on the surface, but it can be confusing if you don't remember much math from school. It's easy enough to convert $100 to foreign currency while traveling, but converting currencies when analyzing a foreign stock's financial statements can mean big differences when you're trying to make investment decisions.
Let's look at an example of how to calculate exchange rates.
Suppose that the EUR/USD exchange rate is 1.20 and you'd like to convert $100 U.S. dollars into euros. Simply divide the $100 by 1.20. The result is the number of euros: 83.33. Converting euros to U.S. dollars means reversing that process: multiply the number of euros by 1.20 to get the number of U.S. dollars.
One easy way to remember this is to multiply across left-to-right and divide across right-to-left. The ending currency is the desired output of the calculation. In the example above, we divided it across right-to-left to determine how many euros we could purchase with U.S. dollars. Then, we multiplied across left-to-right to see how many U.S. dollars we'd receive from euros.
If you're traveling, you may only care about getting a rough idea of how much your money is worth, but currency traders that are highly leveraged pay attention to each pip. A small fluctuation in a currency matters a great deal to an international investor determining the impact of a $0.0001 difference on $1 billion in revenue.
Below, you can see the euro-to-dollar exchange rate from 1999 to the present.
Reading and calculating exchange rates isn't very difficult, but small errors can lead to big mistakes in some cases. Whether you're an international investor or a traveler, you can use free tools to help reduce the likelihood of making an error. Double-check your work before making a potentially costly mistake that's difficult to undo.
Here are some useful tools to use:
- XE.com: Leading source of currency information that includes an exchange rate calculator for many major currencies around the world.
- Yahoo Finance: Leading portal for financial news and analysis that also has a useful exchange rate calculator for many major currencies.
There are also many apps on the Google Play store and the Apple App Store that can help determine exchanges rates on the spot. Again, it's important to note that these exchange rates may differ from the exchange rates at many airports and banks that may charge a spread.
The Bottom Line
It's easy enough to find exchange rate quotes, but making calculations based on them can be a little more challenging. Investors can use many different online resources to help calculate exchange rates on the spot. They can also learn the basic math needed to calculate exchange rates. This can help save a lot of time and money, especially when dealing with significant amounts of money.
Frequently Asked Questions (FAQs)
How are exchange rates determined?
Exchange rates in the forex market are largely determined by free-market forces, but the actions of central banks and governments can influence those forces. When investors increase their demand for a certain currency, that currency's exchange rate will rise. Demand can rise or fall for any number of reasons, including the strength of a nation's economy and central bank monetary policy.
How does inflation affect exchange rates?
When a nation experiences inflation, its currency's value decreases. All else remaining equal, an inflationary currency will lose value in its forex pairs.
How do you calculate forward exchange rates?
Forward exchange rates are contractual agreements to exchange currencies at a set rate on a specific day in the future. They're often used by businesses that do large amounts of overseas sales and want to hedge against currency fluctuations. Banks will typically set the conditions of forward exchange rates based on the current spot price plus the carrying cost. The carrying cost is the spot rate (the ratio of the two currencies' interest rates) multiplied by the time frame of the forward contract.