How to calculate exchange rate?
The truth about living in a modern digitalised world is that you don’t really need to learn how to work out exchange rates – just type your query in Google (e.g., “100 USD to EUR”) and voila – here’s your answer. But suppose you’re abroad, looking at a price tag in a souvenir store and don’t have an internet connection, what then? In this case, knowing how to work out the currency conversion rate would come in handy. Whether you’re a frequent traveller, sending money to family abroad or have any cross-border business relations, understanding how the FX works will help you make smarter financial decisions.
What is an exchange rate?
The exchange rate is the value of one country's currency in other countries' currencies. In other words, currency is a commodity like any other and can be bought at a set price. You can buy dollars for euro, euros for yuan, lira, krona or any other currency. The question is – how much you would get at a given date or time. The world economy changes all the time and so does the value of currencies. However, it is not only the economy alone that dictates the rate you exchange funds at but also the bank, FX broker, exchange shop or any other business providing you the exchange service.
Different kinds of exchange rates
Before we go to the formulas, let’s start by digging into why some FX rates change all the time while others stay constant.
Flexible exchange rates
If a country chooses a floating exchange rate system for its currency, the government does not interfere in regulating it. In this situation, the exchange rate constantly fluctuates based on the economy, import and export, supply and demand. For example, the demand for goods from your country may attract foreign investors, thus foreigners will need more of local currency to buy the goods, as a result its value will rise.
Fixed exchange rates
In contrast, the fixed exchange rate system means that the country’s central bank sets a certain exchange rate for its currency against one or some of the world's popular currencies (usually USD or EUR) and undertakes to maintain it. In order to do that it needs to hold substantial foreign exchange reserves.
Factors that affect exchange rates
There are many factors affecting exchange rates, let’s look at some of the most impactful ones.
Financial stability
As we already mentioned, a strong economy and its growth potential are what stimulate the influx of foreign investors and make the currency stronger. On the other hand, the currency weakens when investors pull money out of the country. This can happen due to political instability, high rates of inflation, country debt or anything that may pose a threat to the business climate.
Interest rates
Additionally, the FX rates are affected by central bank interest rates. Higher rates normally make the currency stronger. Just like regular people who may consider moving their money to a bank that offers a higher deposit rate, investors will generally gravitate towards the countries that can give them a higher return on their investment.
Money supply
Another aspect that affects exchange rates greatly is money supply – it’s the amount of cash a country’s government has issued. If a country decides to print more money, the prices of the commodities will go up. It will simultaneously diminish the value of its currency and the exchange rates because now the supply of the currency is bigger, and it is easier to get hold of.
Where to find current exchange rates?
The interbank rate is always available on Google. Often referred to as the ‘real’ rate or the midmarket rate, it is never passed on to clients – FX services make money by adding a fee or a margin on top of it. You can also check the exchange rate comparison websites; however, it is the end provider of the service who will give you the most accurate information. Most of them show their rates on their websites or even have a convenient online calculator. We have one at MultiPass – click here to get a taste of our exchange rates in some of the currencies we offer.
How to read the exchange rate?
If you were wondering how to read currency exchange rates to buy and sell different currencies, here’s an easy explanation for you. Let’s say your home currency is euro. You go to your local bank branch and see this on the exchange rate table:
USD – Buy: 1.07; Sell: 1.04*
This means that the bank is ready to buy USD dollars from you for 1.07 USD per euro and sell you USD dollars for 1.04 USD per euro.
Here’s how reading exchange rates can help you in real life. E.g., you need to go on a holiday and would like to have 100 USD in cash for snacks and souvenirs in the stores they don’t accept cards. You go to an exchange service and look at the sell rate.
Your 100 EUR gets multiplied by 1.04 and you receive 104 USD.
Now here’s another example, you have returned from your holiday and still have 20 USD unspent, you’d like to exchange them back for euros. In this case, we look at the buy rate.
Your 20 USD get divided by 1.07 and you get 18.69 EUR.
What is the formula for calculating exchange rates?
The exchange rate formula is very simple, you’ll only need your basic math skills – multiplying and dividing. The fixed exchange rate formula is
(A) The amount you have x (B) the exchange rate = (C) the output in foreign currency
Rotate it however you wish to suit your needs. E.g., if you need to buy 100 USD and would like to understand how much of your local currency you will need for this operation, take C (100 USD) and divide by B.
If you know your amount and output sums from the online FX calculator on your bank’s website but you wish to check what exchange rate has been applied to compare it with other banks/FX service providers, take C and divide by A.
Different currency exchange deals
It is not a secret that some FX service providers offer better exchange rates than others. A couple of digits difference in the exchange rate may not affect your wallet that much if you’re converting just a bit of travel money for your holiday. However, if you are a business that regularly transfers high-value payments, it can result in significant overspending or savings.
Suppose you have suppliers in China and have to pay them in yuan. A conventional bank gives you a 6.8298 rate while MultiPass gives you 7.0392.*
Conventional bank: 10 000 EUR multiplied by 6.8298 will give you 68 298 CNY
MultiPass: 10 000 EUR multiplied by 7.0392 will give you 70 392 CNY
Choosing a better rate, in this case, gives you almost 300 EUR of difference. Now imagine you are making ten similar payments in foreign currency – that’s over 3 000 EUR of savings.
Conclusion
As international trade continues to grow, it is no surprise increasingly more businesses choose to take control over their FX management. At MultiPass we empower them with a multicurrency payment account to hold, collect, send and convert over 70 currencies at wholesale exchange rates. Learn more here.
*The FX rates in this article are provided for reference only.