How Does The Exchange Rate Work And How To Get The Best?

Anyone who sends money abroad faces a problem: choosing the right exchange rate.

Even people who regularly make money transfers can find it difficult to understand exactly how exchange rates work.

To make your transfers easier, we have collected valuable information on this topic: What is the definition of an exchange rate? What is it used for? How does the exchange rate work? Where to get the best exchange rate? How do you know if the exchange rate is good? Why does the exchange rate change? How to calculate the exchange rate? We answer all these questions and introduce you to Rates (www.rates.fm) to help you get the best possible price.

What is an exchange rate?

The exchange rate is the value of the national currency (its exchange rate) in relation to the exchange rate of another country. It represents the amount of foreign currency that can be purchased for a unit of another currency. For example, suppose that the hryvnia, cash flow is 688 billion hryvnias for 05/23/2023: for 1 US dollar = 36,870 hryvnias.

How is the currency exchange rate fixed?

The currency exchange rate is conducted in the market, which is the “foreign exchange market”, also called Forex. Like any competitive market, the currency market is governed by the law of supply and demand. That is, to simplify, the more a currency is in demand in international trade, the more its price (and therefore its value) increases. Therefore, the price of a currency is constantly changing (daily and even intraday) according to this mechanism of supply and demand.

Theoretically, the currency exchange rate can be fixed or floating.

A fixed rate is a constant rate that is determined against a reference currency (which is usually the US dollar or the euro). This exchange rate is established by the decision of the state that issues this currency and can be changed only by the decision on devaluation or revaluation of this state.

The floating rate changes with each transaction depending on the supply and demand of each of the two currencies in the foreign exchange market. Thus, the price of the currency increases every time demand exceeds supply.

In a floating exchange rate system, a fall in the market price of a currency is called a depreciation, while an increase is called an appreciation. In the system of fixed exchange rates, the change in the exchange rate is decided by the official authorities of the issuing country of this currency: a decrease in the official parity is called devaluation, increase, or revaluation. It is important to remember: the floating rate system has been adopted by most countries since 1973.

Why is it so important to look at the currency exchange rate?

The exchange rate is important in the country’s economy, especially for its foreign trade.

In fact, when the value of the currency of country A rises relative to the currency of country B, this reduces the competitiveness of goods exported from country A to country B and, on the other hand, increases the competitiveness of goods imported into country A from country B.

So is it better to have a strong currency (in this case the euro) or a weak one?

One of the primary issues facing the political elite in this or that nation is this query. The biggest drawback of a strong currency is that it makes it harder for businesses to compete internationally. “When you offer something in USD to a customer whose currency is devalued, they pay a premium on the exchange rate, which plainly devalues the asset.

A strong currency, on the other hand, is advantageous for purchasing power. This enables lower payment for imported items, such as gasoline at a petrol station. On the other side, it also increases the competitiveness of foreign goods, allowing Japanese automakers to offer their vehicles at a lower price to drivers in the USA. The US dollar, which is valued higher than all other currencies, is in fact a barrier to the US market’s ability to compete.

Why does the exchange rate change?

Supply and demand

The exchange rate is often low when there is a lot of money in circulation but little demand. On the other hand, if demand is great and there are fewer currencies in circulation, the rate rises.

For instance, a Ukrainian business will sell its hryvnias when it pays an American supplier in dollars. The supply will rise as a result. On the other hand, many visitors from across the world will attempt to exchange their money into hryvnias once they arrive in Ukraine. For example, you can see this when converting currency when paying by card, Visa cards are accepted in 200 countries and also in Ukraine. This will increase demand.

Index of consumer sentiment

Consumer spending and investment often increase when a nation’s citizens feel secure in the stability of its economy (low unemployment or inflation). The currency becomes more appealing to investors as a result, of increasing the exchange rate.

Trade balance

The trade balance of a nation compares the value of exports to the value of imports. The exchange rate is impacted if the balance is not equal. The majority of the nation’s foreign currency is sent overseas when exports outpace imports. The demand rises as a result of third nations purchasing more money. The exchange rate will then fluctuate, as we will see.

Inflation

A rise in prices for goods and services over time in the economy is referred to as inflation. When two nations have divergent rates of inflation, this has an impact on the exchange rate. In fact, the currency of the nation with the most inflation will lose value.

Consider a scenario where a given item costs 100 dollars in the United States and 1,100 hryvnias in Ukraine, with a 1 to 11 exchange rate. The currency rate will rise to $1 = 9.16 UAH if, on the other hand, the identical product costs 120 dollars in the United States and 1,100 hryvnias in Ukraine due to inflation. In contrast, a nation’s currency often has a higher value when inflation is low and steady, which might result in a higher exchange rate.

Interest rates

Banks charge customers and companies’ interest as a fee for borrowing money. They have a direct impact on inflation. In actuality, interest rates increase if it is too high. The currency rate is directly impacted by this.

This content is part of the HWM Partnership.

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