Understanding Currency Trading Rates
A foreign currency exchange rate is determined after pairing two currencies and evaluating the rate of one against another. The value of a currency when paired to the currency of another country does not mean it is the value of the country’s currency against that of a third a country. A currency exchange rate therefore can only be determined between any two countries at any one time.
The currency exchange rate of any particular country only becomes important when trade or money exchange is taking place between the two countries involved. It is therefore of importance to travellers, travelling through a foreign country, with regards to how much that currency will buy them, in comparison to that of their own currency, when it is converted into the foreign country's currency. The exchange rate is important for the tourist industry in any country as to which country's tourists they will attract and to whom it will be financially prohibitive. The currency exchange rate will also affect trade as it will either make imports cheaper or dearer, the same goes for exporters. Trade is especially important, in that much of the world trade is done in American dollars therefore if your country's currency appreciates higher than that of the American dollar it will make exports dearer on the world market and make imports cheaper. The reverse happens when a country's currency exchange rate depreciates against the American dollar.
Currency Rate Quotation
In most forex trading markets around the world, there are two types of quotation given to determine the exchange rate of a currency. These are either a direct quotation or an indirect quotation.
A direct quotation is where the quote is shown using the country’s base currency as being the price currency. This is the standard for most countries. For example, if you lived in Europe and you were being quoted how many Euros you would need to spend in order to buy 1 US dollar, your quote would look like this:
- EUR 0.8084 = USD 1.00
An indirect quotation is generally used more frequently in Australia, New Zealand and some of the Euro-zone. This is where the base currency unit is quoted as 1 and the foreign currency is quoted as a relative value by comparison. This means for every 1 Australian dollar you trade, you’ll receive a variable amount of the foreign currency you’re trading against, like this:
- AUD 1.00 = USD 0.8757
Fluctuations in Currency Trading Rates
The value of a country’s currency will fluctuate depending on a number of macroeconomic factors. However, as a basic rule of thumb, any currency is more likely to become more valuable if the demand for that currency is higher than the supply available.
Unfortunately, the opposite is also true, where a country’s currency will become less valuable if there is plenty of supply compared to the demand for it.
Speculators, governments and large banks may tend to invest in foreign currencies when the interest rate return on the foreign amount they’ve bought is high enough to warrant holding a long position. As a country’s interest rate rises, this increases the demand for that particular currency. Conversely, as a country’s interest rates fall, investors tend to look elsewhere for economies offering more preferable interest rates.
A country’s economic health and growth can impact on that country’s currency exchange rates also. Things like Gross Domestic Profit (GDP), national employment levels and other economic factors can play a part. A healthy, strong economy can signify a better performing currency value, while a struggling country may experience poor performance or even a decline in currency values.
Likewise, high inflation can often decrease the value of a currency, although there are times when rising inflation can have the opposite effect. This could be partially due to speculators buying that currency based on an expectation of that country’s central bank raising interest rates to slow the rate of inflation.
Political conditions can also have a serious effect on the forex exchange rates. Political upheaval or instability can be considered to impact negatively on any nation’s economy.
The Workings of the Foreign Exchange Market
Foreign exchange markets operate by trading in what is known as 'tiers.' The biggest buyers and sellers in the market trade with each other and what they are paying is what you see displayed each day in the media. Smaller foreign exchange traders also trade among each other even though, when looked at as a whole, they trade in quite large amount of business. This means there can be many tiers in the market at any one time and the prices paid are quite volatile.
As the market is in operation 24 hours a day it sometimes occurs that only small amounts are needed to be exchanged but there are only the bigger participants available. When this happens the small trade will be charged a 'spot' rate (otherwise known as the exchange rate or benchmark), the smaller the amount the larger the price. This can come about when a person travelling to a war torn country or one close to financial collapse, needs to exchange his or her country's currency for that of the economically precarious country. Few people would want that country's currency so they would jump at the chance to get hold of some American dollars or British pounds and you could make the currency exchange at a very cheap rate. If, after your visit you have some of that currency left over and want to convert the other way, you would find it very hard to effect the exchange because nobody will want to take the currency from you.
Travellers buy From the Retail Tier
Travellers will often experience the situation where the currency exchange rate will be offered to them two to three units (cents) below the 'spot' market price. This is known as the 'retail' tier. The difference represents the profit the seller is making on the transaction. If a large amount is to be exchanged a better price will be able to be negotiated.
Some foreign exchange rate bureaus will also charge a fee, or commission, in addition to the variation in the exchange rate. The lesson here is to make a large transaction whenever you can in preference to making smaller transactions, and at the same time try to choose a foreign exchange trader that doesn't 'double dip.'
Credit Cards Make Trading Easier
The easiest way to navigate your way around the different currency exchange rates in the different countries you visit is to use your credit card. Your credit card company will automatically make the conversion every time you make a purchase but some cards charge a hefty fee for this service. It is therefore in your interest to check with your bank or credit card company before embarking on your trip so you fully understand where you stand financially, and don’t receive a nasty shock when you return home and get your statement.
With the growing use of the internet, PayPal is becoming quite useful as a converter of foreign currencies and it does so through your own bank. Other handy places are through banks, post offices, and some financial institutions. The main thing to keep in mind when making the conversion is to know your currency exchange rate. If you are in any doubt you can find it out on Google. Google has up to the minute rates on a large number of currency pairs and it only takes a few minutes of your time to find out if you are being treated unfairly. Just because there is foreign exchange counter in a major airport doesn't mean it’s not there to make a significant profit from you. It may not be, but if you enter the transaction with some knowledge of what your currency exchange rate should be through your own research, you can back off and seek out another fairer exchange.