An exchange rate is how much it costs to exchange one currency for another. Exchange rates fluctuate constantly throughout the week as currencies are actively traded. This pushes the price up and down, similar to other assets such as gold or stocks. The market price of a currency--how many U.S. dollars it takes to buy a Canadian dollar for example--is different than the rate you will receive from your bank when you exchange currency. Here's how exchange rates work, and how to figure out if you are getting a good deal. (For the more advanced investor, you might want to check out Investopedia's article, "Currency Exchange: Floating Rate vs. Fixed Rate" or "What economic indicators are most used when forecasting an exchange rate?")

Finding Market Exchange Rates

Traders and institutions buy and sell currencies 24 hours a day during the week. For a trade to occur, one currency must be exchanged for another. To buy British Pounds (GBP), another currency must be used to buy it. Whatever currency is used will create a currency pair. If U.S. dollars (USD) are used to buy GBP, the exchange rate is for the GBP/USD pair. Live rates for several major currency are available on the Investopedia Forex page.

Reading an Exchange Rate

If the USD/CAD exchange rate is 1.0950, that means it costs 1.0950 Canadian dollars for 1 U.S. dollar. The first currency listed (USD) always stands for one unit of that currency; the exchange rate shows how much of the second currency (CAD) is needed to purchase that one unit of the first (USD).

This rate tells you how much it costs to buy one U.S. dollar using Canadian dollars. To find out how much it costs to buy one Canadian dollar using U.S. dollars use the following formula: 1/exchange rate.

In this case, 1 / 1.0950 = 0.9132. It costs 0.9132 U.S. dollars to buy one Canadian dollar. This price would be reflected by the CAD/USD pair; notice the position of the currencies has switched.

Yahoo! Finance provides live market rates for all currency pairs. If looking for a very obscure currency, click the "Add Currency" button and type in the two currencies being used to get an exchange rate. Find charts, with live market rates, for most currency pairs on

Conversion Spreads

When you go to the bank to covert currencies, you most likely won't get the market price that traders get. The bank or currency exchange house will markup the price so they make a profit, as will credit cards and payment services providers such as PayPal when a currency conversion occurs.

If the USD/CAD price is 1.0950, the market is saying it costs 1.0950 Canadian dollars to buy 1 U.S. dollar. At the bank though, it may cost 1.12 Canadian dollars. The difference between the market exchange rate and the exchange rate they charge is their profit. To calculate the percentage discrepancy, take the difference between the two exchange rates, and divide it by the market exchange rate: 1.12 - 1.0950 = 0.025/1.0950 = 0.023. Multiply by 100 to get the percentage markup: 0.023 x 100 = 2.23%.

A markup will also be present if converting U.S. dollars to Canadian dollars. If the CAD/USD exchange rate is 0.9132 (see section above), then the bank may charge 0.9382. They are charging you more U.S. dollars than the market rate. 0.9382 - 0.9132 = 0.025/0.9132 = 0.027 x 100 = 2.7% markup.

Banks and currency exchanges compensate themselves for this service. The bank gives you cash, whereas traders in the market do not deal in cash. In order to get cash, wire fees and processing or withdrawal fees would be applied to a forex account in case the investor needs the money physically. For most people looking for currency conversion, getting cash instantly and without fees, but paying a markup, is a worthwhile compromise.

Shop around for an exchange rate that is closer to the market exchange rate; it can save you money. Some banks have have ATM network alliances worldwide, offering customers a more favorable exchange rate when they withdraw funds from allied banks.

Calculate Your Requirements

Need a foreign currency? Use exchange rates to determine how much foreign currency you want, and how much of your local currency you'll need to buy it.

If heading to Europe you'll need euros (EUR), and will need to check the EUR/USD exchange rate at your bank. The market rate may be 1.3330, but an exchange might charge you 1.35 or more.

Assume you have $1000 USD to buy Euros with. Divide $1000 by 1.3330 to get 740.74 euros. That is how many Euros you get for your $1000. Since Euros are more expensive, we know we have to divide, so that we end up with fewer units of EUR than units of USD.

Now assume you want 1500 euros, and want to know what it costs in USD. Multiply 1500 by 1.35 to get 2025 USD. Since we know Euros are more expensive, one euro will more than one US dollar, that is why we multiply in this case.

The Bottom Line

Exchange rates always apply to the cost of one currency relative to another. The order in which the pair are listed (USD/CAD versus CAD/USD) matters. Remember the first currency is always equal to one unit and the second currency is how much of that second currency it takes to buy one unit of the first currency. From there you can calculate your conversion requirements. Banks will markup the price of currencies to compensate themselves for the service. Shopping around may save you some money as some companies will have a smaller markup, relative to the market exchange rate, than others.

Related Articles
  1. Investing Basics

    Learn How To Trade Crude Oil in 5 Steps

    Crude oil and energy markets are specialized venues. Here are five steps to take to build consistent profits.
  2. Forex Education

    The Most Famous Forex Traders Of All Time

    The five most famous forex traders share common virtues such as strong self-confidence.
  3. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  4. Forex Fundamentals

    Buying Yuans as a Long-Term Investment: Risks and Rewards

    Examine the current state of the Chinese currency, the renminbi/yuan, and learn whether it is considered a good long-term investment.
  5. Mutual Funds & ETFs

    Top 3 German Bonds ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and private bonds issued by Germany with different duration yields.
  6. Economics

    A Long Road to Full Diplomatic Relations with Cuba

    Over the past 50 years, the U.S. and Cuba have remained at odds, only recently to restore diplomatic ties. What does this mean?
  7. Forex Fundamentals

    Oil & Currencies: Understanding Their Correlation

    Crude oil shows tight correlation with movements in many currency pairs.
  8. Economics

    How US Interest Rates Move the World Economy

    Because the US has the world's largest economy, fluctuations in America's interest rates affect much more than domestic growth
  9. Forex

    How Much Leverage Is Right for You in Forex Trades

    It isn’t economics or global finance that trip up first-time forex traders. Instead, a basic lack of knowledge on how to use leverage is at the root of trading losses.
  10. Investing Basics

    What is the Sensex?

    The Sensex is the benchmark index for the Bombay Stock Exchange in India.
  1. How does inflation affect the exchange rate between two nations?

    The rate of inflation in a country can have a major impact on the value of its currency and the rates of foreign exchange ... Read Full Answer >>
  2. What economic indicators are most used when forecasting an exchange rate?

    The economic indicators used to forecast an exchange rate are the same ones used to determine the overall economic health ... Read Full Answer >>
  3. Under a pegged exchange rate system which of the following measures can be undertaken ...

    Under a pegged exchange rate system which of the following measures can be undertaken by a ... Read Full Answer >>
  4. You observe the following exchange rates in the following markets ...

    You observe the following exchange rates in the following markets: New York: 120yen/$, Tokyo: 57yen/DM and Frankfurt: ... Read Full Answer >>
  5. How are international exchange rates set?

    International currency exchange rates display how much one unit of a currency can be exchanged for another currency. Currency ... Read Full Answer >>
  6. How often do exchange rates fluctuate?

    Exchange rates float freely against one another, which means they are in constant fluctuation. Currency valuations are determined ... Read Full Answer >>
  7. How are foreign exchange rates affected by commodity price fluctuations?

    In the foreign exchange (forex) market, currency valuations move up and down as a result of many factors, including interest ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!