Converting Currencies: Your Guide to Understanding FX Rates
Dealing with foreign exchange, or FX, comes with the territory of being an international business, which is why it is critical to understand how FX rates work if you want to get the most out of your cross-border transfers.
If you’re new to the foreign exchange market, then converting currencies can be a lot more complicated than you’d think. This is why so many businesses rely on banks and online remittance services to take charge of their foreign currency needs. The problem: If you’re not careful or aware of how and when money is transferred, you’ll likely end up spending unnecessary funds on FX spreads or hidden fees.
How can you avoid this? Let’s break down everything you need to know about calculating FX rates, how the market drives them and how you can get the most bang for your buck.
What is an FX rate?
The FX rate refers to the rate at which you can trade one nation’s currency for another nation’s currency. For example, if the GBP/USD exchange rate is 1.31, it means it would cost you 1.31 US dollars to buy 1 British pound. Conversely, 1 USD would get you 0.76 worth of GBP.
How are FX rates calculated?
FX trading takes place in an international market for buying and selling currencies. Over 25 times larger than all of the world’s stock markets combined, forex trading is open to different types of buyers and sellers. Trading takes place 24 hours a day, except on weekends, which is why the exchange rate for most currencies fluctuates constantly.
Source: ForEx Market Hours, 03 May 2022
The nine factors that influence currency exchange rates:
- Inflation, by means of relative purchasing power of a currency compared to other currencies.
- Interest rates, which are tied tightly to inflation and exchange rates.
- Public debt, in which most countries use large-scale deficit financing, essentially borrowing funds to finance economic growth.
- Political stability. The more stable a country is, the more it can attract foreign investment.
- Economic health, or the performance of a country.
- Balance of trade, or the relative difference between a country’s imports and exports.
- Current account deficit, which is closely related to the balance of trade.
- Confidence or speculation. Sometimes, currencies can be affected by the confidence traders have in a currency.
- Government intervention. Essentially a collection of tools, governments can leverage these to manipulate their local exchange rate.
What are the different exchange rates?
There are two different kinds of exchange rates to be aware of – fixed and floating:
- Fixed exchange rates are a type of exchange regime in which a currency’s value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold.
- Floating exchange rates change continuously. Essentially not backed by a resource, floating exchange rates are determined by a country’s current supply and demand.
What is the mid-market FX rate?
The mid-market exchange rate is the exchange rate at which banks trade currencies between one another. Calculated simply as the midpoint between the buying and selling prices of the two currencies, and agreed upon by global banks, it is the midpoint between the bid and ask rate.
Why do exchange rates change so frequently?
The primary reason exchange rates change is the change in supply and demand of certain currencies in the market, which can be affected by interest rates, inflation, a country’s economic situation, and more.
The stronger a country’s economy, the more likely investors are to inject capital into the country, thus strengthening its currency. However, factors like financial instability or political turmoil can be detrimental to a country’s currency exchange rate.
The war in Ukraine is a prime example. When Russia invaded the territory, and global nations imposed sanctions on the country in retaliation, the rate of the Russian ruble (RUR) plummeted.
Needless to say, currency exchange is all about timing. To mitigate the risk of losing money due to factors outside of your control, you can protect your business by employing hedging strategies, such as currency forwards and options, or buying foreign exchange risk insurance.
How do I find the exchange rate?
Currency conversion calculations may seem overwhelming and complex at first, especially if you’re not a fan of numbers and formulas. For those of us who didn’t ace maths in school, there are a host of modern financial tools online that you can use to help you read true market FX rates. These include money exchange websites and foreign currency trading apps that offer real-time FX information. If you’re travelling, exchange rates are also usually posted at banks, airports and currency exchange stores.
However, if you want to calculate the exchange rate, simple tools for doing so are available on a number of trusted sites, i.e. XE.com.
Your competitive foreign exchange solution
If your business is sending and receiving money abroad, it’s essential that you understand the fundamentals of exchange rates. At the end of the day, it’s imperative to ensure you get the best possible rate for your currency transfers each time.
In addition to knowing how much your money transfer method will cost you, you should also note how much money will be received on the other end after exchange rates and fees are applied.
As we mentioned above, some banks and online remittance services can assist you in converting your currencies — but they aren’t always transparent when it comes to fees and you may be hit by unnecessary currency conversion charges that chip away from your bottom line. Fortunately, there is an easier solution.
At Currenxie, you always get the genuine mid-market rate – just like the one you see on XE.com and Google. In turn, this can equate to savings up to 8x more than if you exchanged your currencies with traditional banks. With Currenxie, you won’t need to worry about hidden FX spreads thanks to our completely transparent fees:
Get in touch with us today to find out how we can help you get the best FX rate for your business.