Currency Exchange Rate

People usually do not deal with exchange rates unless they travel to a foreign country. The truth is they are constantly affecting economic conditions both in the United States and abroad. Travelers lacking in experience sometimes marvel at the multiplication of currency units that can take place. Exchanging U.S. dollars for Japanese yen yields many more individual yen than individual dollars. The traveler is not suddenly richer. The amount of yen he is holding is equivalent to the amount of dollars he previously held in terms of purchasing power.

Currencies are important to economic growth. The stock of physical money allows transactions to be made for different classes of goods and services by expressing them in terms of prices. When citizens or companies from two different countries want to do business with one another, they have to exchange each other’s currencies. When two currencies are priced in terms of each other, the result is a pair of exchange rates. They often do not exactly match, but they track one another very closely. This exchange rate reflects the supply of each currency relative to the demand for each currency.

Many factors influence the supply and demand characteristics of each currency. The total number of currencies in the world numbers 175, each of which belongs to a country with its own unique history, economy, government and culture. Every country has its own economic indicators that vary wildly from month to month. Inflation rates, interest rates, industrial production, Gross Domestic Product and balance of trade are all closely-watched indicators by the global forex market. As soon as new pieces of data come in, speculators and traders get to work adjusting the exchange rates by buying and selling currencies in the open market.

The exchange rate is a vital piece of information for any participant in the foreign exchange (forex) market. Participants include governments, central banks, international corporations, international financial institutions like banks, travelers, diplomats, soldiers, speculators and anyone who needs foreign currencies for whatever purpose. The buying and selling of these currencies influences the exchange rates by altering the supply and demand details for each currency. Every currency is valued relative to every other currency. As a result, currencies are quoted and traded in pairs.

A currency pair represents the exchange rate between two currencies. An example of a currency pair is the USD/EUR pair, where USD represents the U.S. dollar, and EUR represents the euro. The dollar is the base currency, the currency being sold, and the euro is the quote currency, the currency being bought. The exchange rate tells a buyer how much of the quote currency is needed to buy the base currency. A speculator that buys the USD/EUR pair is selling dollars and buying euros. Likewise, a speculator that buys the reverse pair, EUR/USD, is selling euros and buying dollars. Exchange rates like these help central banks set monetary policy, assist international businesses in calculating profits or losses, and aid foreign governments in valuing their foreign exchange reserves accurately.

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