What Are Currency Exchange Rates Based On?

Currency exchange is the act of trading one currency for another, and you use it when you need to make transactions with merchants in another country who use a form of money that is different from yours. You’ll also need to do this if you do business abroad, travel to another country, or even have a savings account in a foreign currency. That said, this exchange is rarely one-to-one. You can’t simply trade five USD and get five EUR back. The rate differs based on supply and demand as affected by commodities, inflation, and investments.

What Are Currency Exchange Rates?

Currency exchange rates refer to the price of one currency to another currency. For example, if a single EUR costs 1.16 USD, you have to pay 1.16 USD for every EUR you buy. So if you’d like 10 EUR, you’ll need to pay 11.60 USD.

Currency exchange rates can either be fixed or floating, and this distinction helps decide how much a currency is worth.

Fixed Currency Exchange Rates

A government determines a fixed rate through its central bank. It’s “pegged” against another significant world currency, usually USD, EUR, or JPY, and follows the movement of the other currency’s value. For example, most Caribbean countries peg their currencies to USD since their primary source of income is derived from tourism in dollars. 

Countries usually fix their currencies to maintain economic stability and to safeguard the competitiveness of their goods and services. It also keeps interest rates low and regulates currency fluctuations.

Floating Currency Exchange Rates

Most countries have floating rates, which constantly change due to supply and demand for each currency in the free market. If the need for the currency is high, then its value goes up and vice versa. Other economic factors, including government policies, can also affect these rates. However, the implementation of safeguards helps control fluctuations from seeing significant fluctuations in their value.

Most major world currencies operate on floating rates, such as the USD, the GBP, and JPY.

Why Do I Need To Know Currency Exchange Rates?

You need to know currency exchange rates if you’re making any transaction using another currency, like investing in foreign stocks, buying or selling products internationally, or if you send and receive money from abroad. For example, suppose you’re a remote freelancer. In that case, the difference between the gross income and net income received in your paycheck might be affected by these rates, so it’s good to know currency values to receive the correct compensation.

Factors That Affect Currency Exchange Rate

Currencies are bought and sold, just like any other products on the market. If the demand for it is high, then its value goes up. But if the demand is low, then its value decreases.

Supply and demand changes based on several economic factors, but these are generally affected by:

Commodities

Countries that produce or export major commodities typically enjoy higher exchange rates since others need to exchange their currency to buy products such as oil. For example, if oil prices go up in an oil-producing country, then another country that imports oil from them will have to exchange more of their currency, driving up the currency value for the country producing oil.

Inflation

Inflation means prices for commodities in a country go up, lowering the purchasing power of their currency. The costs of exports increase while the domestic demand for goods decreases, both depreciating the currency’s value.

Investments

The more people want to invest in a country, the higher the value of its currency because foreign investors will have to exchange their money for the local currency in order to enter the market. Adversely, if a country’s economic status is unstable and is therefore unattractive to investors, the currency typically decreases in value.

How to Protect Yourself From Fluctuating Currency Exchange Rates

It can be challenging to conduct financial transactions if you’re bowing to the whims of currency exchange rates. However, there are ways to protect yourself from fluctuations by transacting with and storing your money in multi-currency accounts designed to stabilize your cash. These types of accounts allow you to hold money in different significant currencies helping you control their value versus having to exchange them each time, risking a loss in each transaction. We offer exactly that type of account here at Cashero, so be sure to look into the details of our multi-currency account.

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