A:

Generally speaking, when Country A's currency is worth more than that of Country B, it does not necessarily mean that Country A's economy is stronger than B's. For example, Japan's economy is regarded as one of the world's strongest, and yet a single Japanese yen exchanges for considerably less than US$1. On the other hand, Cyprus' economy is considerably smaller than the U.S. economy, but Cyprus' currency, which is the pound, exchanges for about twice as much as the U.S. dollar.

The fact of the matter is that looking at a currency's worth relative to that of another currency at a static point in time is meaningless; the best way to judge a currency's worth is to watch it in relation to other currencies over time. Supply and demand, inflation and other economic factors will cause changes to a currency's relative worth, and it is this change in value that can be used to evaluate worth.

For example, let's say that at the beginning of the year, the U.S. dollar was worth 1.75 XYZ dollars (a fictitious currency), and six months later, the U.S. dollar is worth 2.00 XYZ dollars. In this case, the U.S. dollar increased in value over the XYZ dollar by around 14%. This change could be due to XYZ having higher inflation, or to just an overall lower demand for the XYZ dollar.

A currency's purchasing power can also be used as an indicator of the relative worth of currencies. For example, if US$1 can be exchanged for XYZ$1, it would appear that the XYZ dollar is worth as much as the U.S. dollar. However, if the purchasing power of XYZ$1 is equal to only US$0.50, then you can conclude that the U.S. dollar is worth more than the XYZ dollar, because a single U.S. dollar can be used to buy more goods than a single XYZ dollar can.

To learn more about currency trading, see Commodity Prices And Currency Movements, Wading Into The Currency Market and Common Questions About Currency Trading.

RELATED FAQS
  1. Why would my stock's value decline despite good news being released?

    More often than not, when a firm releases an earnings report the market will react to this news by adjusting the firm's stock ... Read Answer >>
  2. What is foreign exchange?

    Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free economy, a country's ... Read Answer >>
  3. 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 Answer >>
  4. 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 Answer >>
  5. How do you make money trading money?

    How someone makes money in forex is a speculative risk: you are betting that the value of one currency will increase relative ... Read Answer >>
Related Articles
  1. Investing

    Currency Swap Basics

    A currency swap involves two parties exchanging a notional principal and interest to gain exposure to a desired currency.
  2. Investing

    Explaining Fixed Exchange Rates

    A government using a fixed exchange rate has linked the value of its currency to the value of another country’s currency, or the price of gold.
  3. Trading

    Profiting From a Weak U.S. Dollar

    Learn how to allocate your investments when the U.S. dollar is down.
  4. Trading

    Drastic Currency Changes: What's The Cause?

    Currency fluctuations often defy logic. Learn the trends and factors that result in these movements.
  5. Trading

    Interest Rate and Currency Value And Exchange Rate

    In general, higher interest rates in one country tend to increase the value of its currency.
  6. Trading

    The 6 Most-Traded Currencies And Why They're So Popular

    Every currency has specific features that affect its underlying value and price movements in the forex market.
  7. Trading

    The Effects Of Currency Fluctuations On The Economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate of one currency versus the other is influenced by ...
  8. Trading

    How Do You Make Money Trading Money?

    Making money in the foreign exchange market is a speculative process. You are betting that the value of one currency will increase relative to another.
RELATED TERMS
  1. Dollar Rate

    The exchange rate of a currency against the U.S. dollar (USD). ...
  2. Reciprocal Currency

    In the foreign exchange market, a currency pair that involves ...
  3. Funding Currency

    The currency being exchanged in a currency carry trade. A funding ...
  4. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  5. Dollar Bull

    An investor or speculator who is optimistic about the outlook ...
  6. Quote Currency

    The second currency quoted in a currency pair in forex. In a ...
Hot Definitions
  1. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  2. Pro-Rata

    Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the ...
  3. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
  4. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  5. Backward Integration

    A form of vertical integration that involves the purchase of suppliers. Companies will pursue backward integration when it ...
  6. Pari-passu

    A Latin phrase meaning "equal footing" that describes situations where two or more assets, securities, creditors or obligations ...
Trading Center