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Calculating currency exchange rates

29 Nov 2021 00:00:00 | Update: 29 Nov 2021 00:10:35
Calculating currency exchange rates

Exchange rates are important to both travelers and international investors. It’s pretty easy to find exchange rate quotes these days. But, you still need to know how to read them and make calculations based on them. In this article, we will take a closer look at currency exchange rates.

You can find exchange rates in a number of different places, ranging from banks to websites like XE.com. If you’re traveling, you can often find rates posted at airports or local banks. If you’re trading in the foreign exchange (“forex”) market, look at your trading platform for real-time information.

Quotes themselves are always given in pairs since currency values are always relative to one another. Not surprisingly, the US dollar and euro are the two most commonly quoted currencies given their status as reserve currencies at many global central banks. The most popular currency pair is, therefore, the EUR/USD, which is the number of dollars needed to purchase one euro.

These currency pairs fluctuate all the time due to various economic factors, including supply and demand, different economic indicators, commercial and hedging activity, and hedge fund or financial trading. The changes amount to just fractions of a currency’s value. These fractions are known as “pips” by those trading currencies.

It’s also worth noting that many airport currency exchanges make money by charging a wider spread between the currencies. They don’t charge an outright fee, but they make money by exaggerating the exchange rate differences. You can often get the best deal by exchanging currencies through your local or foreign bank.

Calculating exchange rates may seem simple on the surface. But, it can be confusing if you don’t remember much math from school. It’s easy enough to convert $100 to foreign currency while traveling. But, converting currencies when analyzing a foreign stock’s financial statements can mean big differences when you’re trying to make investment decisions.

Let’s look at an example of how to calculate exchange rates.

Suppose that the EUR/USD exchange rate is 1.20 and you’d like to convert $100 U.S. dollars into euros. Simply divide the $100 by 1.20. The result is the number of euros: 83.33. Converting euros to U.S. dollars means reversing that process: multiply the number of euros by 1.20 to get the number of US dollars.

An easy way to remember this is to multiply across left-to-right and divide across right-to-left. The ending currency is the desired output of the calculation. In the example above, we divided it across right-to-left to determine how many euros we could purchase with US dollars. Then we multiplied across left-to-right to see how many US dollars we’d receive from euros.

If you’re traveling, you may only care about getting a rough idea of how much your money is worth. But currency traders that are highly leveraged pay attention to each pip. A small fluctuation in a currency matters a great deal to an international investor determining the impact of a $0.0001 difference on $1 billion in revenue.

 

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