Definition: An exchange rate is the price of a country’s currency in terms of another currency. In other words, it represents how many units of a foreign currency a consumer can buy with one unit of their home currency.
What Does Exchange Rate Mean?
What is the definition of exchange rate? Exchange rates are ratios that are used across all international markets, including finance, trading, and investment. Businesses and investors use these rates to compare their currency’s purchasing power with another country’s. They also use this to determine the comparative strength of their domestic currency against foreign currencies.
Additionally, these rates can either be floating or fixed. A floating rate occurs when the market determines the rate. A fixed rate is where a country pins their domestic currency to some widespread currency.
Let’s look at an example.
Example
Jane is a trader in the currency department of a large, multinational bank. Every day, she places trades in dozens of currencies in exotic, foreign markets. However, to conduct her day-to-day responsibilities, she needs to be aware of major rates such as the USD to GBP, or the USD to Euro. Today, she has to place one complicated trade: convert $1,000 to the GBP, and then the Euro for a client who wants to transfer money between banks. First, Jane must know the rate for the currencies involved.
After conducting thorough research, she finds 1 USD is equal to 0.75 GBP, and 1 GBP is equal to 2 Euros. Her conversions using each rate is as follows: $1,000 is exchanged for 750 GBP, then the 750 GBP is exchanged for 1500 Euros. Jane has fulfilled her client’s order, and successfully used currency rates to facilitate the flow of capital throughout the world.
Exchange rates are absolutely vital in this global economy. If they are unfavorable, they can skew investment returns and topple exchange ideas. In contrast, a favorable currency rate, with a strong domestic currency, is great for imports due to “cheaper” international goods, while a weaker foreign currency is great for exports, due to “cheaper” goods produced domestically for countries abroad.
Summary Definition
Define Exchange Rates: Currency exchange rate means the ratio that one currency can be traded for another.
