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What Are Exchange Rates?

Exchange rates are constantly in flux.
Foreign currency is converted based on exchange rates.
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  • Written By: Felicia Dye
  • Edited By: Heather Bailey
  • Last Modified Date: 26 August 2014
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Yen, euros, and dollars are all types of currency. Exchange rates refer to the prices of buying, selling, or converting money. Unless one currency is pegged to another, exchange rates are constantly in flux. Since these rates can change, thereby affecting the values of different currencies, many people turn to the foreign exchange (FX) market as a means to earn profits.

Without exchange rates, international trade would be very difficult. It would also be very difficult for a person from one country to travel to any other country that uses a different currency. These difficulties would arise from the fact that in most countries only one type of currency is widely accepted. Without that type of currency, transactions cannot take place. Without exchange rates, there would not be a system established that provided the value of one currency compared to another.

When a person has one type of currency, such as yen, and he wants another type of currency, such as euros, he must buy that money. The party that has a desired currency and provides it to the party who wants it in exchange for another type of currency is the seller. The exchange is generally conducted based on an internationally recognized price known as the exchange rate. For example, 10 euros may purchase 1,000 yen.

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Though according to the current exchange rate 10 euros should purchase 1,000 yen, it may actually require 12 euros to get 1,000 yen. The extra two euros are likely to be a commission and fee. Such charges are often added to the exchange rate to provide profits for those who provide exchange services.

When one currency is pegged to another, there is a fixed exchange rate. If, for example, the yen was pegged to the euro, 1,000 yen would always be equivalent to 10 euros. However, most currencies are not pegged, meaning their value is constantly fluctuating. Exchange rates can move in favor or against any particular currency, which translates into profits and losses, depending on the currency a person has and when he exchanges it.

Consider the example above where a person exchanged euros for yen at a rate of 10 for 1,000. If the yen strengthens, that individual can take the 1,000 yen back to the point of exchange and it may purchase 15 euros. This happens when the exchange rates fluctuate in a manner that makes one currency more valuable than it previously was and another currency less valuable than it previously was.

Since the value of currency fluctuates this way, many people become FX traders. These individuals aim to use exchange rates to their advantage. Their goal is to purchase currencies and sell them for other currencies at times when profits can be made.

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Melonlity
Post 1

What are some good ways to find the lowest commission rates? If, for example, someone travels to a foreign country, is there a way to find out what commission rates are standard and which companies charge around the rate, above it, offer a discount, etc.? That would be some great information for travelers.

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