Foreign exchange rate
(Wordnet Dictionary)Updated: 2006-10-17 14:32
In finance, the exchange rate between two currencies specifies how much one currency is worth in terms of the other. For example an exchange rate of 8 Chinese yuan to the US Dollar means that RMB1 is worth the same as US$1. An exchange rate is also known as a foreign exchange rate, or FX rate.
An exchange rate quotation is given by stating the number of units of a price currency can be bought in terms of a unit currency. For example, in a quotation that says the Euro-United States Dollar exchange rate is 1.2 dollars per euro, the price currency is the dollar and the unit currency is the euro.
Quotes using a country's home currency as the price currency are known as direct or price quotation (from that country's perspective) and are used in the US and most other countries.
Quotes using a country's home currency as the unit currency are known as indirect or quality terms quotation and are used in British newspapers and are also common in Australia and New Zealand.
- direct quotation: Home Currency / Foreign Currency
- indirect quotation: Foreign Currency / Home Currency
Note that, using direct quotation, if a unit currency is strengthening (i.e. appreciating, i.e. if the currency is becoming more valuable) then the exchange rate number increases. Conversely if the price currency is strengthening, the exchange rate number decreases and the unit currency is depreciating.
Mechanics of trading
In practice it is rarely possible to
exchange currency at the exact rate quoted. Market makers who match together
buyers and sellers will take a commission. This is achieved by quoting a
bid/offer spread.
Free or pegged
If a currency is free-floating its
exchange rate against other countries can vary against other such currencies. In
fact such exchange rates are likely to be changing almost constantly as quoted
by financial markets and banks around the world. If the value of the currency is
"pegged" its value is maintained by the government in question at a fixed rate
relative to the other currency. For example, in 1983 the Hong Kong dollar was
pegged to the United States dollar.
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