If you plan on taking a trip abroad, there’s a lot of information you need to scrounge around to discover. You may start asking questions like, “How long does it take to transfer money into your account once you’re abroad?”, “Why do bank transfers take so long?”, and “What is the exchange rate between two specific currencies?”.
Understanding how exchange rates work is vital. Sure, you could rely on Google, credit card companies, airport exchange counters, banks, or someone else to handle the conversions for you. But sometimes, knowing how to do the calculations yourself is imperative to avoid getting ripped off while traveling. Also, knowing how much your money is worth will help you calculate any losses, know which payment method to use, and plan your trip.
With that said, are you wondering how to calculate the exchange rate between two currencies? It’s a simple calculation. It entails dividing the amount you have by the amount you’ll get back after the conversion. Before walking you through these calculations, we’ll start by discussing what exactly an exchange rate is, how to read it, and why it fluctuates.
What Is An Exchange Rate? How Do I Read It?
In simple terms, the exchange rate depicts the amount of one currency you get for a unit of another currency. That’s why you’ll find quotes written in pairs since currency values are always relative to one another. But in most cases, you’ll notice that the United States Dollar and the Euro are used as the quoted currency by most banks and financial institutions.
There is a logical explanation for this. Financial institutions hold the mentioned currencies in significant quantities. That’s why they are known as reserve currencies and used as international currencies. Yet this isn’t to say you can’t calculate exchange rates among other currencies.
For clarity’s sake, let’s say you see an exchange rate between USD/AUD written as 1.33. What this means is it costs 1.33 Australian dollars to get one US dollar. We might as well take this opportunity to mention how the order in which the currencies appear matters when calculating exchange rates. In the case of USD/AUD, it means USD is the first currency. And the first currency will always stand for one unit of that particular currency. It follows that the exchange rate outlines how much of the second currency (in this case, AUD) is required to purchase one unit of the first currency (USD).
Why Exchange Rates Fluctuate
You’ll find that exchange rates aren’t stagnant. They tend to fluctuate constantly as the currencies trade. For instance, high demand for a particular currency means its value will increase, and the opposite applies. As such, the fluctuations push the price of the money up or down. Apart from supply and demand, several other economic factors cause currency pairs to fluctuate. Interest rates, inflation, public debt, terms of trade, and financial performance are examples of aspects that contribute to exchange rate fluctuations.
Calculating The Exchange Rate Between Two Currencies
And now for a simple math lesson. Calculating an exchange rate is pretty straightforward if you use the following formula:
- Exchange rate = Starting Amount (Original Currency) / Ending Amount (New Currency)
Example: Let’s say you have $100 and exchange it for €80. Using the formula outlined above, you calculate the exchange rate as follows:
- 100/80 = 1.25
As mentioned, the starting amount matters. If you had €80 and exchanged it for $100, then the exchange rate is calculated as follows:
- 80/100 = 0.8
We’ll reiterate how knowing how to calculate the exchange rate yourself will spare you a lot of confusion. But there’s no harm in using the different calculation tools available to do the work for you. As hinted before, credit cards automatically calculate the exchange rate for you. So, all you have to do is swipe! You can also take advantage of online platforms that provide different exchange rates. You can even leave it to the banks to do the calculations for you, although they tend to add a mark-up for the service. Online platforms like Cashero also provide exchange rates and you can switch between the different currencies very easily.
Conclusion
Hopefully, you’re now in a position to calculate the exchange rates between two currencies yourself. Call it self-empowerment, if you will. But, as we said, there’s no shame in using other tools to handle the calculations for you if it’ll make your life easier.
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