Exchange Rate

Loading the player...

What is an 'Exchange Rate'

The price of a nation’s currency in terms of another currency. An exchange rate thus has two components, the domestic currency and a foreign currency, and can be quoted either directly or indirectly. In a direct quotation, the price of a unit of foreign currency is expressed in terms of the domestic currency. In an indirect quotation, the price of a unit of domestic currency is expressed in terms of the foreign currency. An exchange rate that does not have the domestic currency as one of the two currency components is known as a cross currency, or cross rate.

Also known as a currency quotation, the foreign exchange rate or forex rate.

BREAKING DOWN 'Exchange Rate'

An exchange rate has a base currency and a counter currency. In a direct quotation, the foreign currency is the base currency and the domestic currency is the counter currency. In an indirect quotation, the domestic currency is the base currency and the foreign currency is the counter currency.

Most exchange rates use the US dollar as the base currency and other currencies as the counter currency. However, there are a few exceptions to this rule, such as the euro and Commonwealth currencies like the British pound, Australian dollar and New Zealand dollar.

Exchange rates for most major currencies are generally expressed to four places after the decimal, except for currency quotations involving the Japanese yen, which are quoted to two places after the decimal.

Let’s consider some examples of exchange rates to enhance understanding of these concepts.

  • US$1 = C$1.1050. Here the base currency is the US dollar and the counter currency is the Canadian dollar. In Canada, this exchange rate would comprise a direct quotation of the Canadian dollar. This is easy to understand intuitively, since prices of goods and services in Canada are expressed in Canadian dollars; therefore the price of a US dollar in Canadian dollars is an example of a direct quotation for a Canadian resident.
  • C$1 = US$ 0.9050 = 90.50 US cents. Here, since the base currency is the Canadian dollar and the counter currency is the US dollar, this would be an indirect quotation of the Canadian dollar in Canada.
  • If US$1 = JPY 105, and US$1 = C$1.1050, it follows that C$1.1050 = JPY 105, or C$1 = JPY 95.02. For an investor based in Europe, the Canadian dollar to yen exchange rate constitutes a cross currency rate, since neither currency is the domestic currency.

Exchange rates can be floating or fixed. While floating exchange rates – in which currency rates are determined by market force – are the norm for most major nations, some nations prefer to fix or peg their domestic currencies to a widely accepted currency like the US dollar.

Exchange rates can also be categorized as the spot rate – which is the current rate – or a forward rate, which is the spot rate adjusted for interest rate differentials.

RELATED TERMS
  1. Quote Currency

    The second currency quoted in a currency pair in forex. In a ...
  2. American Currency Quotation

    A direct quotation in the foreign exchange markets whereby the ...
  3. Dollar Rate

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

    In the foreign exchange market, a currency pair that involves ...
  5. Currency Substitution

    The use of a foreign currency in transactions in place of the ...
  6. Currency Board

    A monetary authority that makes decisions about the valuation ...
Related Articles
  1. Forex Education

    What is an Indirect Quote?

    An indirect quote expresses the amount of foreign currency required to buy or sell one unit of the domestic currency in the foreign exchange markets.
  2. Forex Education

    Forex Tutorial: Reading a Forex Quote and Understanding the Jargon

    One of the biggest sources of confusion for those new to the currency market is the standard for quoting currencies. In this section, we'll go over currency quotations and how they work in ...
  3. Forex Education

    Understanding The Spread in Retail Currency Exchange Rates

    Understanding how exchange rates are calculated and shopping around for the best rates may mitigate the effect of wide spreads in the retail forex market.
  4. Forex Fundamentals

    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 ...
  5. Markets

    What Happens in a Currency Crisis?

    A currency crisis comes from a decline in the value of a country’s currency.
  6. Investing Basics

    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.
  7. Forex Education

    How Are International Exchange Rates Set?

    International exchange rates show how much one unit of a currency can be exchanged for another currency.
  8. Forex Fundamentals

    Understanding the Floating Exchange Rate

    Floating exchange rate is the exchange rate between two currencies at any given time.
  9. Economics

    Macroeconomics: Currency

    By Stephen Simpson For citizens of different countries to conduct trade, they have to buy and sell each other's currencies. The price of a nation's currency, expressed as an amount of a second ...
  10. Forex Education

    Interest Rate and Currency Value And Exchange Rate

    In general, higher interest rates in one country tend to increase the value of its currency.
RELATED FAQS
  1. What types of companies benefit from reporting results utilizing constant currencies ...

    Understand constant currency figures, and explore some of the reasons why a company is likely to benefit from reporting using ... Read Answer >>
  2. What is the value of one pip and why are they different between currency pairs?

    In forex markets, currency trading is done on some of the world's most powerful currencies. The major currencies traded are ... Read Answer >>
  3. Why do forex traders use a currency converter?

    All currencies are quoted in pairs - one country's currency against another country's currency. A currency converter is used ... Read Answer >>
  4. 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 >>
  5. What are key economic factors that can cause currency depreciation in a country?

    Read about the causes of currency devaluation, and find out how to differentiate between relative and absolute currency devaluation. Read Answer >>
  6. How does the balance of payments impact currency exchange rates?

    Take a brief look at the relationship between a nation's balance of payments and the exchange rate value of its currency ... Read Answer >>
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center