A Brief Guide About Currency Exchange and Exchange Rate

by Samantha Gibbs Blogger

Before you send money to abroad, you need to know about all inns and outs of currency exchange and exchange rates. Here's my brief guide.

Currency Exchange

Currency Exchange is something that most investors and world travelers have to consider from time to time. Exchange rates refer to the difference in value between to currencies. For example, if you have five units of one currency, but you are visiting a foreign country, the value may not be the same there. You will need to find out how much your five units are worth in that location and exchange it for a local currency. In many cases, the overall value of a currency will go up or down based on the demands of the market.

If you are interested in currency exchange, then you probably need to review the foreign exchange market (which is also called the currency market, forex or FX). This financial market is intended for trading currencies. Although it is not centralized, it operates all over the world with a variety of buyers and sellers. The currency market is available at all hours, which is expected considering time zone variations throughout the world. This market is responsible for determining currency exchange rates.

How it helps In Business

There are a number of ways that the currency exchange is used in business and investing. In business, there may be a need to work within multiple currencies when a company handles transactions from all over the world. For example, if a United States based company needs to ship the product to another company or consumer in Britain, they will need to pay for shipping in Pound Sterling. Although they pay for shipping this way, the payment they receive from the organization or individual receiving the shipment will most likely be converted into U.S. dollars. The company is working in both currencies when necessary.

There are also investors who take advantage of the fluctuation of currency exchange rates. This is often referred to as carrying trade. What this means is an investor will borrow a low yielding currency. They will take the borrowed currency and invest it in one that is high yielding. By working with the currency exchange rate, they can turn a profit.

Before the 1970s, currency exchange rates were usually fixed. After the 1970s most shifted to floating exchange rates, which formed the modern version of the foreign exchange market. Today, most individuals and organizations will purchase a quantity of one currency by paying with a quantity of another. The current foreign exchange market is unique because it is not geographically centered, it never closes during the week and gives those who use currency exchange a way to enhance profit margins.

Exchange Rates

If you have ever dealt with multiple currencies, then you have probably had to consider exchange rates. Other terms are often also applied, including the foreign-exchange rate, FX rate or Forex rate. Simply stated, the exchange rate is the amount that a unit of one currency can be exchanged for a unit of another currency. Not all currency carries the same value, so this is necessary to ensure that the proper value is given when one is traded for the other.

Types of Exchange Rates

There are different types of exchange rates you may need to consider. The forward exchange rate is a rate that is quoted and traded for today although the payment is delivered on a future date. The spot exchange rate is the current value, or rate, at this moment. There are a number of ways to obtain exchange rates, however, the individual must know which currency they are exchanging for. Today, some people use the internet as an easy way to estimate currency exchange rates.

There are other factors that can determine the exchange rate of one currency to another. For example, a currency may be considered free floating or pegged. If it is utilizing an adjustable (or movable) peg system, then it is fixed or matched to the value of another currency. Some peg systems allow one currency to be matched to a group of others. It can also be measured against the value of another kind of unit, such as gold. If the peg system is adjustable, that means it includes a provision in case there is currency devaluation.

Free Floating

When a currency is considered free-floating, it is permitted to vary. The value will be based on the current supply and demand of the world markets. Free-floating exchange rates are usually quoted by banks and financial institutions frequently because they can constantly change. Free-floating exchange rates can go either up or down with no provision in case of devaluation.

Just like the buying and selling of items or services, a currency’s value is based on the demand for it. When it is in higher demand, its value will rise. If demand for the currency lowers, its value will also go down. At any given time, currencies that are based on the market can shift in either direction. When one goes down, that does not mean no one wants to use it. What it usually means is that people are choosing to hold their financial wealth in another form. This is usually another type of currency. Whether you are a financial investor or someone who plans to travel to other countries, you may need to be aware of current exchange rates.