What is an Exchange Rate?

Published by Thomas Herold in Banking

'Exchange Rate' is explained in detail and with examples in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

In finance and business, exchange rates are also known as Forex Rates, foreign exchange rates, or FX rates. These exchange rates are the rates that are valid between two currencies. They are stated in terms of one currency’s value in the other currency. Such an exchange rate is also the foreign nation’s currency value as stated in the currency of the home nation.

There are various distinctions within the category of exchange rates. Present day exchange rates are termed spot exchange rates. Exchange rates which are quoted to you and traded today but available for payment and delivery in the future on a particular date are called forward exchange rates.

It is instructive to look at some examples. If the GBP/USD rate is 1.60, then it means that the exchange rate of the British Pound garners $1.60 in US dollars. Alternatively, a USD/CHF rate of .97 would mean that only .97 of a Swiss Franc will buy one U.S. dollar.

Exchange rates are determined on the foreign exchange market. This is the largest single market on the whole planet, trading literally trillions of dollars in currency values every single day. It is estimated that this market exceeds three trillion dollars in U.S. valued currencies on a given trading day. This market trades six days a week, and is only closed from Friday at 5PM New York time until Sunday afternoon at 3PM New York Time.

Exchange rates can be freely trading on the world exchange markets. Some countries choose to instead peg the value of their currency to another proven, more responsible, and reliable currency, such as the Euro or the dollar. In these cases, the exchange rates are constant against those that they peg to, and only fluctuate against other currencies on the market at the same pace as the currency that they are pegged to does.

Exchange rates on FOREX can be pursued for hedging purposes or for investment opportunities. Businesses that have operations in two or more countries are often interested in locking in their exchange rate in order to protect themselves from possibly violent currency swings. By buying forward exchange rates, they can lock these in for any given day that suits their needs. Alternatively, they can take on FOREX spot positions in the currency totals that they anticipate needing, so that as the price rises and falls, it will be canceled out as they repatriate their foreign currency back into home currency.

Investors can participate in the exchange rate markets for investment opportunities. Besides buying these spot currency positions or forward positions, they can purchase options contracts on these pairs. The advantage and disadvantage to these markets is the leverage that they provide, which is commonly one hundred to one. This signifies that an individual investor is able to control one hundred thousand Euros against the dollar with only a thousand dollar account value. Major gains, as well as substantial losses, become possible with only small moves, since every ten cent price change in this case represents a hundred dollars literally gained or lost.

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The term 'Exchange Rate' is included in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.