Exchange rates are an essential part of today’s society. Without them, we wouldn’t be able to check the price of products or services in another currency. Everyday goods for hundreds of billions of dollars are imported and exported between countries, and for this kind of trade to exist all involved parts need access to the latest exchange rates.
An exchange rate is a difference in value between two currencies and we use these rates to keep track of what one currency is worth in another currency. A few examples of when you will need a forex rate are when you travel when you buy products from other countries, and when you want to trade currencies on the forex market. We are in other words completely relying on accurate exchange rates on a day to day basis in order to live our lives.
On this page, we will cover everything you need to know about currency exchange rates and the relationship between different currencies. We also offer tips about tools you can use to exchange or invest in currencies.
What is a Currency?
For you to fully comprehend how an exchange rate works you first need to understand what a currency is and how it gets its value. A currency is money that is used in one or several countries. Hundreds of years ago when we used coins as payments the coins represented their own value in weight. A coin made from copper had a lesser value than a coin made from gold and so on. But that’s not how it works anymore.
In today’s society currencies and money exist in bills and coins (and often as a number on a computer) that has no value on its own. Humans have decided that different denominations in different currencies have different values. For example, you can buy one kilo of rice for 2 dollars even though the rice is actually worth more than the material the dollars are made from. That’s something we all accept.
When this kind of currency was first introduced every country had to have gold for the same value as the money that was created.This system is called the gold standard. It works as an insurance and is what represent the currency’s value. If a country decides to coin 1 million coins they are required to have gold for the same value. Without the gold, the currency loses its value.
The gold standard is something that has been used during different times in history. There have been times when countries and regions have created money without a gold reserve and that kind of money is called fiat money. Gold is also not the only thing that can be used as a reserve, silver is the second most popular material and other metals have been used as well.
If you want to learn more about currencies and how they function we recommend that you read our article about currencies here. We offer information about the history of money, different currencies, how currencies affect society, and currency unions.
What is an Exchange Rate?
A foreign exchange rate, or just an exchange rate, is the value of one currency in another country’s currency – how much you have to pay with your currency to get a certain amount of a different currency.
When we wrote this article 1 American dollar (USD) was worth 0.8905 Euro (EUR), and that number is the exchange rate for USD to EUR. However, all forex rates comes in two different versions. The above example could also be shown as the price for exchange rate today between EUR and USD; today 1 EUR costs 1.1752 USD. Note that currencies are normally written with 4 decimals.
Here is another example using the Euro and British Sterling Pound (GBP).
1 EUR = 0.8948 GBP
1 GBP = 1.1174 EUR
There are two different currency exchange rates that you need to know about – floating exchange rates and fixed exchange rates (sometimes referred to as a pegged exchange rate).
- The floating exchange rate is the most used system today and in many eyes the best exchange rate. The rate of a currency that has a floating exchange rate is determined by the market. This kind of system is also called a flexible exchange rate since the rate changes a lot.
- A fixed exchange rate is the opposite of a floating exchange rate. Instead of being controlled by the market a currency gets pegged to another rate. The rate could be another currency, a basket of currencies (an index), or a commodity. So if a currency is pegged to the price of gold it will increase and decrease whenever the rate of gold does.
Exchange Rates Role in Society
As you probably understand, exchange rates have a huge impact on everything in today’s society. Without current exchange rates, we wouldn’t be able to trade with other countries because export and import would be impossible. We would also not be able to go traveling in other countries since we wouldn’t be able to buy or use their currency.
In the section above we mentioned that a floating exchange rate is affected by a country’s economy and that is 100% true. What we didn’t mention is that a country’s economy can be affected by the exchange rate. When a currency’s value increases export to other countries gets more expensive and at the same time import gets cheaper. The result of this is a stronger and more stable economy.
Currency trading is one of the most popular forms of investment in the world. This type of trading is normally called forex trading or fx trading. The basic concept is straightforward and completely based on currency exchange rates. To invest in currencies you buy a currency pair or exchange rate. The investment is made by you “betting” on the currency you think will have an increased value by the time you sell it. For example, you can buy the currency pair USD/EUR and put your money against either the USD or the EUR. Today trading different currencies is very popular with brokers that offer platforms where this is very simple to do. Anyone can set up an account and start trading, but not everyone can do so and be profitable.
Currency rates tend not to fluctuate too much, especially compared to other forms of trading like the stock market where prices can vary a lot on a day to day basis. Therefore, you have to invest bigger amounts on the forex market. If you don’t have access to big amounts of money you can use leverage – a type of loan that brokers offer to their customers. If you’re interested in learning more about the forex market you can do that here, and click here if you want to start trading currencies. Find a broker for Forex trading:
Popular Exchange Rates
You can see a list of the forex markets most popular currencies below. As you’ll notice, it’s actually a list of the strongest currencies in the world. This is because these currencies are stable and trustworthy which makes them safer for investments. The fact that they are world leading also means that they are available everywhere. Many currency brokers do not offer smaller currencies.
- The American Dollar is the world’s leading currency and the one that most people buy and sell on the forex market.
- The Euro is the currency used in the Eurozone and it’s a good investment. Currently, there are several currencies pegged to the Euro.
- The British Sterling Pound is another one of our world’s leading currencies and a popular choice for investments such as GBP/USD and GBP/JPY.
- The Japanese Yen has over the last 50 years grown to become one of the most stable currencies in the world. This is thanks to Japan’s impressive economic advances and the fact that they are not completely relying on Western markets.
- The Canadian dollar is a stable anti pole to the American dollar.
- The Swizz Franc is one of the strongest currencies in Europe and an interesting investment option. The central bank in Switzerland is known to focus a lot of effort on keeping the currency stable.
Different Exchange Rates
Something you have to be aware of is that current exchange rates can differ depending on who you ask. It might seem strange since the value of a currency should be an exact number but let us explain to you why it is not.
The reason is that the banks that offer the exchange rates can make money from your exchange with them. By adding a little bit to every sell rate they offer and deducting a bit from every buy rate they make sure they always make a profit on transactions.
We recommend that you always double check rates when you exchange money or buy products in another currency. We also recommend that you don’t go to a bank that will make sure the rates only fit their agenda, instead you should use an independent currency converter like the one we offer to get the best exchange rate.