How to understand Currency Exchange Rates?
We often consider currency exchange rates when we are traveling to another country or when we are trading in shares and debentures. We are concerned about the rates and we want the best for the maximum value of our money. But, what are the factors that affect currency exchange rates? Sometimes, the value of a currency falls and sometimes it goes up. The currency exchange rates keep fluctuating every day.
For a better understanding of the currency exchange rates, you should be aware of the terminology and the factors that affect rate fluctuations. Here, we have discussed these in detail.
Exchange Rate Terms
First of all, let us know about the widely used terms in currency exchange rates:
- Sell Rate – This is the rate at which a traveler sells foreign currency to get local currency. For example, if you are heading to Europe from India, you will sell Rupees to get Euros.
- Buy Rate – This is the rate at which you buy the foreign currency in exchange for the local currency. For example, if you are coming back to India, you will buy Rupees in exchange for Euros.
The Process of Currency Exchange
While trading, buying and selling of currencies is compulsory. As mentioned earlier, this is dependent on the currency exchange rates. In a trade, one currency is exchanged for another currency. For example, if you want to buy Euros, you need some other currency to buy it. Let us consider that you use US Dollar to buy Euros. In this case, the exchange rate will be determined for EUR/USD pair. The whole currency conversion is dependent on this pair. There are various trading portals that list all the pair values.
How to Read an Exchange Rate?
Let us say, the current exchange rate for EUR/USD is 1.1150. The first currency, Euro in this case, always denotes a single unit. The second currency, USD in this case, will show the value that will be needed to buy a single unit of Euro. If we consider this exchange rate, you will need 1.1150 USD to buy 1 Euro.
Similarly, if we consider the vice-versa situation, you can determine how much units of Euro will be used to buy 1 USD. For this, you can simply, inverse the EUR/USD rate, like 1/currency exchange rate. With reference to above rate, the inverse rate will be,
1/1.1150 = 0.8968
This means that 0.8968 EUR will be used to buy 1 unit of US Dollar.
Currency Exchange at the Dealers Outlet
The aforementioned currency exchange rate was the market exchange rate, the true value. But when you want to exchange currencies, you will not get the conversion as per the market rate. The dealers, for example, banks and agents, they charge their profits for the conversion services. Hence, the exchange value is slightly diminished.
Let us consider the same example. If you want to convert US Dollar to Euro, according to the exchange pair, the value of 1.1150. When you go to the dealer, he or she might offer the currency exchange rate of 1.1550. The difference between the two values is their profit. If you would like to calculate profit percentage of dealers, you can do so by the following method:
1.1550 – 1.1150 = 0.040
0.040/1.1150 = 0.036
Profit Percentage = 0.036×100 = 3.6%
The dealers charge a profit for their money transfer services because they are providing cash. In the market, where currencies are exchanged, there is no provision for cash dealing. If you want to avail cash, then you have to pay processing fees. Similarly, when banks or other dealers provide cash to you, they charge their fees.
If you would like to get the best currency exchange rates, you can consider ATM’s for currency exchange. You can also use credit cards that do not charge processing fees on currency conversion.
Now, you can calculate the value of a currency based on the currency conversion pair. You can determine the currency exchange rates for getting the maximum value for your currency.