In finance, the exchange
rate between two currencies specifies how much one
currency is worth in terms of the other. For example
an exchange rate of 120 Japanese Yen to the Dollar
means that ¥120 is worth the same as $1. An exchange
rate is also known as a foreign exchange rate, or FX
An exchange rate quotation is given by stating the
number of units of a price currency can be bought in
terms of a unit currency . For example, in a
quotation that says the Euro - United States Dollar
exchange rate is 1.2 dollars per euro, the price
currency is the dollar and the unit currency is the
euro. The usual unit currency varies by geographic
location. For example, British newspapers quote
exchange rates with British pounds as the unit
currency. This is known as indirect or quality terms
quotation and is also common in Australia and New
Quotes using a country's home currency as the unit
currency are known as direct or price quotation and
are used in most other countries.
Note if a unit currency is strengthening /
appreciating (i.e. if the currency is becoming more
valuable) then the exchange rate number increases.
Conversely if the price currency is strengthening,
the exchange rate number decreases and the unit
currency is depreciating.
In practice it is rarely possible to exchange
currency at the exact rate quoted. Market makers who
match together buyers and sellers will take a
commission. This is achieved by quoting a bid/offer
spread. For example if you are bidding to buy
Japanese yen you would do so at the bid price of say,
¥115 per dollar, and if you were offering to sell
yen you might do so at ¥125 yen per dollar.
If a currency is free-floating its exchange rate
against other countries can vary against other such
currencies. In fact such exchange rates are likely
to be changing almost constantly as quoted by
financial markets and banks around the world. If the
value of the currency is " pegged " its value is
maintained by the government in question at a fixed
rate relative to the other currency. For example, in
2003 the Hong Kong dollar was pegged to the United
States dollar .
Fluctuations in exchange rates
A market based exchange rate will change
whenever the value of either of the two component
currencies change. A currency will tend to become
more valuable whenever demand for it is greater than
the available supply. It will become less valuable
whenever demand is less than available supply (this
does not mean people no longer want money, it just
means they prefer holding their wealth in some other
form, possibly another currency).
Increased demand for a currency is due to either an
increased transaction demand for money, or an
increased speculative demand for money. The
transaction demand for money is highly correlated to
the countries level of business activity, gross
domestic product (GDP), and employment levels. The
more people there are out of work, the less the
public as a whole will spend on goods and services.
Central banks typically have little difficulty
adjusting the available money supply to accommodate
changes in the demand for money due to business
The speculative demand for money is much harder for
a central bank to accommodate but they try to do
this by adjusting interest rates. An investor may
choose to buy a currency if the return (that is the
interest rate) is high enough. The higher a
country's interest rates, the greater the demand for
In choosing what type of asset to hold, people are
also concerned that the asset will retain its value
in the future. Most people will not be interested in
a currency if they think it will devalue. A currency
will tend to lose value, relative to other
currencies, if the countries level of inflation is
relatively higher, if the country's level of output
is expected to decline, or if a country is troubled
by political uncertainty. For example, when Russian
President Vladimir Putin dismissed his Government on
Feburary 24 2004, the price of the Ruble dropped.
When China announced plans for its first manned
space mission the price of the Yuan jumped.
Like the stock exchange, money can be made or lost
on the foreign exchange market by investors and
speculators buying and selling at the right times.
Currencies can be traded at spot and foreign
exchange options markets. The spot market represents
current exchange rates, where options are
derivatives of exchange rates.
This article is licensed under the GNU Free
Documentation License . It uses material from the
Wikipedia article "Exchange rate" .