What are Currency Exchange Rates?
Currencies are an effective way to store value and are around in one form or another for thousands of years. While in the prehistoric times people had to directly trade one product for another, such as sheep for sheep or wheat for wheat, the invention of currencies and currency exchange, made the process of trading immeasurably easier. Today, currencies are considered the most important factor of our rapid economic development in the last few centuries and form the cornerstone of the world’s globalization.
That being said, currencies are in their basic form also a commodity that changes its value based on supply and demand. The price of one currency expressed in terms of another currency is called the exchange rate, and the price of currencies fluctuate on a daily basis just like the price of gold or oil.
How Currencies Are Quoted?
You’ve probably already seen an example of currency exchange and an exchange rate when you went to a holiday trip. Currencies are quoted against each other, where the exchange rate shows the price of the first currency expressed in terms of the second currency.
For example, when you had to exchange your US dollars for your Europe trip, you had been quoted the euro vs. US dollar exchange rate, also called EUR/USD for short by the currencies’ abbreviations. In this case, the first currency is called the base currency (euro) and the second currency is called the counter-currency (US dollar). If the current EUR/USD exchange rate is $1.25, this means that for each euro you have to pay 1.25 US dollars.
What Impacts Exchange Rates?
If you visit Europe every year, you’ve probably noticed that the exchange rate of the EUR/USD currency pair changes each time you go to the exchange office. That’s because exchange rates are affected by the current supply and demand for the involved currencies which fluctuate on a regular basis.
There are many factors that impact the supply and demand for currencies, the most important of which are interest rates, economic growth, inflation rates and so on. Basically, when a currency carries a relatively higher interest rate compared to the other currencies, investors would like to buy that currency which increases the demand and the price of the currency goes up. Similarly, good economic conditions and a higher value of exports of products also increase the demand for the domestic currency, as importing countries have to buy the exporting country’s currency in order to pay for the imported products.
Now that you know what exchange rates are and by which factors they’re affected, you plan your next holiday trip to a country which has a relatively cheap currency and save a portion of your money!