In this lesson summary review and remind yourself of the key terms and calculations related to exchange rates.
Lesson summary
If someone from Hamsterville came up to you and tried to buy an old book from you, and tried to pay you in their currency — the Hamsterville snark () — you’d tell them “no thanks!”
Why? Because the Hamsterville snark is worthless to you since you can’t buy anything with it in your country. Instead, you want to be paid in your own currency. That means that someone from Hamsterville would need to exchange their currency for the currency used in your country.
The exchange rate of a currency is how much of one currency can be bought for each unit of another currency. A currency appreciates if it takes more of another currency to buy it, and depreciates if it takes less of another currency to buy it.
Key terms
| Key term | Definition |
|---|
| exchange rate | the price of one currency in terms of another currency; for example, if the exchange rate for the euro (€) is yen (¥), that means that each Euro that is purchased will cost yen. |
| appreciate | when a currency becomes more valuable relative to another currency; a currency appreciates when you need more of another currency to buy a single unit of a currency. |
| depreciate | when the value of a currency decreases relative to another currency; a currency depreciates when you need less of another currency to buy a single unit of a currency. |
| floating exchange rates | when the exchange rates of currencies are determined in free markets by the interaction of supply and demand |
Key takeaways
The exchange rate is the price of one currency in terms of the other
Currencies are traded in the foreign exchange market. Like any other market, when something is exchanged there is a price. In the foreign exchange market, a currency is being bought and sold, and the price of that currency is given in some other currency. That price is expressed as an exchange rate.
For example, in the market for the Hamsterville snark, the exchange rate of the snark to the U.S. dollar () is per snark. That means in order to buy a single snark, someone from the United States would need to pay for it with .
On the other hand, someone from Hamsterville who wants dollars would buy those dollars with snarks. So, the exchange rate of the dollar is the inverse of the exchange rate of the snark:
Sophie is a reporter for the Hamsterville Courier News and is preparing an article on the exchange rates for three of Hamsterville’s primary trading partners. Unfortunately, she spilled her lime smoothie on her notes and some of the entries in the table she created are missing. Help her out by completing the missing entries in the table below:
| Hamsterville snark () | Galactic credits () | Canadian dollar () |
|---|
| 1 Hamsterville snark (SN) is exchanged for | 1 | 10 | 2 |
| 1 Galactic credit (GC) is exchanged for | | 1 | .2 |
| 1 Canadian dollar () is exchanged for | | | 1 |
Solution:Remember that the exchange rates of any two currencies are inverses of each other. So, if the exchange rate for the Hamsterville snark (SN) is:
Then the inverse of that exchange rate is the exchange rate for the galactic credit (GC):
| Hamsterville snark () | Galactic credits () | Canadian dollar () |
|---|
| 1 Hamsterville snark (SN) is exchanged for | 1 | 10 | 2 |
| 1 Galactic credit (GC) is exchanged for | .1 | 1 | .2 |
| 1 Canadian dollar () is exchanged for | 0.5 | 5 | 1 |
If a currency appreciates it is more valuable; if a currency depreciates it is less valuable
When an exchange rate changes, the value of one currency will go up while the value of the other currency will go down. When the value of a currency increases, it is said to have appreciated. On the other hand, when the value of a currency decreases, it is said to have depreciated.
For example, if it now takes to buy a single Hamsterville snark instead of , the snark has appreciated and its value has increased. If prices in the United States haven’t changed, this is great news for Hamstervillians! Now the snark can buy more goods and services from the United States.
But, this is bad news for Americans who want to buy Hamsterville’s goods and services. Each U.S. dollar now buys only instead of as it did before. The dollar has depreciated against the snark and everything from Hamsterville just got a lot more expensive.
Key equations
Exchange rates
The exchange rate of a currency is expressed as the units of another currency needed to buy a single unit of the currency. For example, the exchange rate for currency A is given below:
Calculating the cost of something with exchange rates
To find the cost of something in the value of another currency, divide that cost by the exchange rate. For example, it takes 300 galactic credits () to buy a smoothie on Tatooine. If the exchange rate means that buys , then the cost of a Tatooine smoothie to a Canadian tourist is:
Therefore a Tatooine smoothie costs to a Canadian.
Common misperceptions
We are used to thinking about buying things with a currency, so many new learners are confused about what the price should be in the market for a currency. But the price of an orange is never given in oranges; it’s given in some other currency. Just like an orange, a dollar can’t be bought with itself, but instead, it needs to be bought with some other currency.
A common misperception is that a strong currency is always what is best for a country. On the one hand, if a currency appreciates, all of its imported goods get a lot cheaper. If a country tends to import a lot more goods than they export, then an appreciated currency might be desirable. But on the other hand, if a country relies heavily on exports, an appreciating currency isn’t such a great thing. When a currency appreciates, the exports from a country that use that currency will decrease because all of those goods are more expensive to countries other currencies.
Questions for review
The Ghanaian cedi currently trades for 20 Icelandic kroné.
- What is the exchange rate of the kroné? What is the exchange rate for the cedi? SHOW YOUR WORK.
- If the trading price changes to 25 kroné per cedi, what has happened to:
- If the cost of a fermented shark sandwich in Iceland is 1500 kroné, what is its cost in cedi to a tourist from Ghana based on a trading price of 1 cedi for 20 kroné? Show your work.
ééé
Remember that exchange rates are always expressed as the amount needed to buy a single unit of the currency described.
é
If the trading price changes to 1 cedi for 25 kroneThe kroné has depreciated. A single cedi can now buy more kroné, so the kroné is cheaper.
b. The cedi has appreciated. A single cedi can buy more of the other currency (the kroné), so the cedi is more valuable.
You need 75 cedi to buy a shark sandwich.
FAQs
What is an Exchange Rate? An exchange rate is the rate at which one currency can be exchanged for another between nations or economic zones. It is used to determine the value of various currencies in relation to each other and is important in determining trade and capital flow dynamics.
How do currency exchange rates work? ›
The exchange rate gives the relative value of one currency against another currency. An exchange rate GBP/USD of two, for example, indicates that one pound will buy two U.S. dollars. The U.S. dollar is the most commonly used reference currency, which means other currencies are usually quoted against the U.S. dollar.
What is the lesson of exchange rate? ›
The exchange rate of a currency is how much of one currency can be bought for each unit of another currency. A currency appreciates if it takes more of another currency to buy it, and depreciates if it takes less of another currency to buy it.
How many US dollars have the same value as euro Khan Academy? ›
If you divide one by 0.87, you are going to get approximately 1.15. And so at the time of this video, 1.15 U.S. dollars is equal to one Euro. Or another way to think about it is, if you took a dollar and 15 cents in the U.S. and convert it to Euros, you would get one Euro. And there's other ways of expressing it.
What is an exchange rate article? ›
An exchange rate measures the price of one currency in terms of another. In turn, the terms of trade measure how many units of the foreign goods can one unit of the domestic good acquire.
What is the basic concept of exchange rate? ›
An exchange rate is a relative price of one currency expressed in terms of another currency (or group of currencies). For economies like Australia that actively engage in international trade, the exchange rate is an important economic variable.
What is the 3 strongest currency? ›
List of Highest Currencies in the World 2024
| Currency | Symbol | INR Value In Rs (As on May 2024) |
|---|
| Kuwaiti Dinar | 1 KWD | 271.36 |
| Bahraini Dinar | 1 BHD | 221.42 |
| Omani Rial | 1 OMR | 216.86 |
| Jordanian Dinar | 1 JOD | 117.91 |
6 more rowsThe world's weakest currency is considered to be either the Iranian Rial or the Venezuelan Bolívar. This is due to the high inflation levels, political conflicts and poor economic health of the countries.
Where is US currency worth the most? ›
Some of the countries where a dollar is worth the most money include Mexico, Peru, Chile, and Colombia. It's possible to exchange dollars for local currency in these countries at favorable exchange rates.
Why is it important to understand exchange rates? ›
Changes in export and import prices arising from a change in the exchange rate mainly influence demand for goods and services that are exported and imported (these are known as tradablegoods and services). But exchange rate movements also have implications for the demand for non-tradable goods and services.
Exchange rates have a significant impact on the prices you pay for imported products. A weaker domestic currency means that the price you pay for foreign goods will generally rise significantly. As a corollary, a stronger domestic currency may reduce the prices of foreign goods to some extent.
What makes a dollar strong? ›
The dollar strengthens when interest rates rise, and international investors view it as a safe haven for maintaining and increasing value during turbulent economic times. In general, the strength and value of a currency depends on the demand for that currency. The dollar will strengthen when demand for it strengthens.
What's worth more $1 or 1 euro? ›
Download Our Currency Converter App
| Conversion rates US Dollar / Euro |
|---|
| 1 USD | 0.92225 EUR |
| 5 USD | 4.61125 EUR |
| 10 USD | 9.22250 EUR |
| 20 USD | 18.44500 EUR |
8 more rowsMultiply the money you've budgeted by the exchange rate. The answer is how much money you'll have after the exchange. If "a" is the money you have in one currency and "b" is the exchange rate, then "c" is how much money you'll have after the exchange. So a * b = c, and a = c/b.
What is a good exchange rate? ›
A good exchange rate means you get the most value for your money during a currency transfer. To determine what's “good,” you must understand what's normal by checking the mid-market rate. This term refers to the midpoint between the buy and sell prices of any two currencies across different vendors and banks.
What does the exchange rate represent? ›
An exchange rate is the rate at which one currency will be exchanged for another currency. It affects trade and the movement of money between countries.
What does the exchange rate determine? ›
Key Takeaways. Aside from factors such as interest rates and inflation, the currency exchange rate is one of the most important determinants of a country's relative level of economic health. A higher-valued currency makes a country's imports less expensive and its exports more expensive in foreign markets.
What is the effective exchange rate in simple words? ›
The effective exchange rate is an index that describes the strength of a currency relative to a basket of other currencies. Typically it is calculated using geometric weighting. It can be computed using the USD as a numeraire.
What is the overview of foreign exchange rate? ›
Foreign exchange rate can also be said to be the rate at which one currency is exchanged with another or it can be said as the price of one currency that is stated in terms of another currency. Exchange rates of a currency can be either fixed or floating.
