Currency Converter

Understanding Foreign Currency Exchange

Key Terms in Forex

Navigating the world of foreign currency exchange (forex) requires understanding some fundamental terms:

• Exchange Rate: This is the value of one country’s money expressed in the currency of another country. It tells you how much of one currency you need to exchange to get a specific amount of another.
• Forex (Foreign Exchange Market): The forex market is a vast, global, and decentralized marketplace where currencies are traded over-the-counter. It’s the largest financial market globally, surpassing even the credit market. This market is essential because the value of one currency rarely matches another exactly, and forex facilitates payments and receipts of equivalent value across different currencies.
• Bid Price: The highest price a buyer is willing to pay to acquire one unit of a specific currency.
• Ask Price: The lowest price a seller is willing to accept to sell one unit of a specific currency.
• Bid-Ask Spread: The difference between the bid price and the ask price. Ideally, buyers prefer narrow spreads, while sellers aim for wider ones. In practice, currency exchanges through brokers, banks, or businesses often involve their own exchange rates with bid-ask spreads that generate a profit margin for their services, sometimes referred to as a fee or commission.
• Pip (Point in Percentage): A pip is the smallest standard unit of price change in a currency quote. For example, a change from EUR/USD 1.2800 to 1.2803 is a difference of 3 pips.
• Currency Pair: A quotation showing the relative value of one currency against another. The first currency listed (e.g., EUR in EUR/USD) is the base currency, and the second (e.g., USD in EUR/USD) is the quote currency or counter currency.
• Interbank Rate: This is the wholesale exchange rate that major banks use when trading currencies with each other. It’s often the closest to the true market value.
• Major Currencies: A consistently recognized short list of the most actively traded currencies worldwide. Currently, these typically include the U.S. dollar (USD), Euro (EUR), Japanese yen (JPY), British pound (GBP), Australian dollar (AUD), Canadian dollar (CAD), and Swiss franc (CHF). Any currency pair involving the USD and another major currency is known as a major currency pair.

What Exactly is Currency?

Currency is a universally accepted medium of exchange within an economy for buying and selling goods and services. Evidence suggests its use dates back at least 3,000 years. Before currency, it’s believed that bartering, the direct exchange of goods and services without money, was the primary method of trade. Throughout history, currency has taken incredibly diverse forms, including coins, barley, gold, silver, animal pelts, large carved stones, salt, knives, shells, stamps, kitchen utensils, spices, tea, and even cheese.

A Brief History of Currency

As history demonstrates, anything a group of people within an economy assigns value to can function as currency. The first “official” currency, in the form of standardized round coins, was minted in the 7th century BC by King Alyattes of Lydia, in what is now modern-day Turkey. Paper currency, on the other hand, originated in Asia and was introduced to Europe by Marco Polo following his travels.

Modern Currency Systems

Today’s currency systems are far more standardized and regulated. Major global currencies primarily exist as physical paper bills and coins, designed for easy portability. However, the majority of an individual’s wealth is typically held in digital accounts. The value of these modern currencies is based on the promise of the issuing governments, classifying them as fiat money – currency declared by the government as legal tender but not backed by a physical commodity. Before fiat systems, currencies were usually tied to the value of a physical commodity like gold or silver.

While we still see and use physical coins and bills, most large-scale currency transactions are conducted electronically. Modern technology employs sophisticated currency exchange mechanisms and systems to facilitate the transfer of funds between digital accounts rather than physical exchange. Even everyday purchases are increasingly made using debit cards, credit cards, and mobile payment systems, reducing the reliance on physical currency.

The Rise of Cryptocurrency

Cryptocurrencies are digital forms of currency that operate independently of a central bank or governmental authority. They utilize encryption techniques to control the creation of new units and to verify the transfer of funds. The underlying technology for most cryptocurrencies is blockchain, a decentralized and distributed ledger that records all transactions across a peer-to-peer network. A key feature of blockchain is that participants can verify transactions without needing a central intermediary like a bank or government. The value of cryptocurrencies, like traditional currencies, can fluctuate, and they can be traded in similar ways. While Bitcoin is currently the most well-known cryptocurrency with the largest market capitalization, numerous other notable cryptocurrencies exist, such as Ethereum (ETH), Litecoin (LTC), and Ripple (XRP). Some experts speculate that cryptocurrencies might potentially become the dominant form of currency in the future. For the purpose of our current calculator, Bitcoin is the only cryptocurrency available for conversion.

Forex and How Exchange Rates Work

Currencies used in different countries almost always have different values. Exchange rates exist as the mechanism to enable the equal exchange of these currencies. Real-time exchange rates are provided by the foreign exchange market (forex), which is also where the majority of currency transactions take place. As mentioned earlier, forex is a global, decentralized, over-the-counter market with trillions of U.S. dollars worth of currency traded daily. The market operates at high speed, with exchange rates constantly changing. The most common forex transactions involve exchanges between the U.S. dollar and the Euro, the U.S. dollar and the Japanese yen, and the U.S. dollar and the British pound Sterling.

Understanding Forex Quotes

A forex quote always involves two currencies: a base currency and a quote currency (also known as the counter currency). Common base currencies include EUR (Euro), GBP (British pound), AUD (Australian dollar), and USD (U.S. dollar). Here’s an example of a forex quote:

EUR/USD 1.366

In this quote, EUR is the base currency, and USD is the quote currency. It signifies that one Euro is worth $1.366 U.S. dollars. In other words, to purchase one Euro, you would need to pay $1.366 USD (excluding any additional fees like commission). The base currency is always valued at one. Conversely, if the EUR/MXN rate (Euro to Mexican Peso) is 17.70, it means you would need 17.70 Mexican pesos to buy one Euro. Globally, many exchange rates are quoted in terms of how much one U.S. dollar is worth in a foreign currency. The Euro is an exception, as its rate is typically quoted in terms of U.S. dollars per Euro.

When buying foreign currencies, you’ll usually see two listed prices: the buying rate and the selling rate. These are also referred to as the bid price and the ask price for the currency pair, respectively. When you buy foreign currency from a bank or exchange broker, you’ll be using their selling (ask) price, which is typically higher than their buying (bid) price. This difference allows currency brokers, like any other merchant, to buy low and sell high to make a profit.

Factors Influencing Currency Exchange Rates

Numerous factors can influence the exchange rates between currencies in the real world. Here are a few key ones:

• Differences in Inflation: Generally, a country with a lower inflation rate will see its currency appreciate in value as its purchasing power increases relative to currencies with higher inflation. Conversely, a currency in a high-inflation economy will usually depreciate against a currency from a low-inflation economy.
• Differences in Interest Rates: Interest rates can impact the demand for a currency and the inflation rate of an economy, which in turn can drive exchange rates up or down. Higher interest rates can attract foreign investment, increasing demand for the currency.
• Trade Deficits: If a country spends more on imports than it earns from exports (including goods, services, interest, and dividends), it operates at a trade deficit. This means it requires more foreign currency than it receives, increasing the supply of its own currency and potentially leading to depreciation.
• Politics: Government policies and regulations can directly or indirectly affect exchange rates. Additionally, countries with stable political environments tend to attract more foreign investment than those with political instability. Perceived instability can erode confidence in a country’s currency, leading to capital flight to more stable economies.
• Economic Performance: The overall health and performance of a country’s economy significantly influence its currency’s exchange rate. Strong economies tend to attract global capital, increasing the demand and thus the value of their currency.

Helpful Tips for International Travelers

If you’re planning to travel to a country that uses a different currency, doing some advance research can be very beneficial.

While whether it’s better to exchange currency abroad or domestically can depend on your destination, it’s generally advisable to exchange your money domestically before you travel. This gives you more time to shop around for better rates and avoids potential difficulties exchanging money in an unfamiliar region where you might not speak the language. In the U.S., some banks and credit unions offer currency exchange services that often provide better exchange rates and lower fees compared to other methods. You can also order foreign currency online through some currency conversion websites that will deliver it to you by mail. While international airports have convenient currency exchange kiosks, they typically offer the worst exchange rates and charge the highest fees.

When buying currency overseas, many people opt for the most convenient option, such as kiosks in airports, hotels, and tourist hotspots, which often take advantage of travelers who don’t want to search for better deals. It’s recommended to first look for an overseas branch or ATM of your own bank. Otherwise, local banks and ATMs with reasonable fees usually offer better exchange rates.

For destinations where credit cards are widely accepted, using credit or debit cards can be more convenient for foreigners, eliminating the need to carry large amounts of foreign cash or pay high commissions. Credit and debit card exchange rates tend to be quite close to wholesale market rates. Furthermore, cards are generally a safer alternative to carrying a lot of cash. However, be aware that many cards not specifically designed for travel perks may charge foreign transaction fees.

It’s common to return from international trips with some leftover foreign currency. While you can keep it as a souvenir, you can also sell it back to a bank or broker. Again, selling back to banks or credit unions is usually preferable in terms of exchange rates and fees.