DEFINITION of International Currency Exchange Rate
An international currency exchange rate is the rate at which two currencies in the market can be exchanged. International currency exchange rates display how much of one unit of a currency can be exchanged for another currency.
BREAKING DOWN International Currency Exchange Rate
The international currency exchange rate is the equivalent amount of money in one currency that can be received for one unit of another currency. For example, USDJPY 113.54 means that an individual or business will receive 113.54 Japanese yen for every US dollar. Currency exchange rates can be floating, in which case they change continually based on a multitude of factors, or they can be pegged or fixed to other currencies, in which case they move in tandem with the currencies to which they are pegged.
There are multiple factors that affect the value of an international currency exchange rate. One factor is an increase or decrease in interest rates in a country, which reflects a change in the international currency exchange rate between two countries. When a country increases its interest rates, foreign investment flows in to capture the high yields that will be gained from investments, such as government bonds. An increase in demand for a country’s investments would lead to an increase in a demand for the country’s currency. When currency demand goes up, the exchange rate is strengthened. The stronger exchange rate would reflect a decline in value of its paired currency. For example, consider the currency pair USDJPY – if interest rates in Japan went up, the US dollar will decline in value to reflect the increase in the JPY.
Another factor that could affect the international currency exchange rate is the implementation of an expansionary monetary policy whereby the money supply in an economy is increased (or decreased). All else equal an increase in the money supply will lead to more of the domestic currency chasing the same quantity of goods and services. This results in a market disequilibrium in which demand exceeds supply, leading to an increase in the price of these goods, and hence, inflation. When inflation increases, the value of the domestic currency decreases.
International currency exchange rates are important in today's global economy. Knowing the value of your home currency in relation to different foreign currencies helps investors to analyze investments priced in foreign currency. For example, for a US investor, knowing the dollar to euro exchange rate is valuable when choosing European investments. A declining US dollar could increase the value of foreign investments, just as an increasing US dollar value could hurt the value of foreign investments.
Exchange Rates and Financial Forecasting
Similarly, the Financial Accounting Standards Board (FASB) and Generally Accepted Accounting Principles (GAAP) require companies that operate in multiple countries to translate the foreign currencies to US dollars on their financial statements. The currency conversion will translate to either gains or losses, depending on the international currency exchange rate between the US dollar and the foreign country’s currency. For example, a Canadian retail importer decides to purchase some merchandise from the US when the international currency exchange rate is CDNUSD 0.80. The value of the merchandise is USD100,000 which translates to CAD125,000. The retailer, factoring in all other casts, decides to sell the merchandise in Canada for CAD143,750, representing a 15% markup. However, before the transaction is finalized with the US manufacturer, the international currency exchange rate fluctuates to CDNUSD 0.74 which means that the Canadian dollar has depreciated in value, and the value of the goods is now CAD135,135.
To profit from the same markup the retailer will have to sell his merchandise for CAD155,405. Given that this may be a costly alternative, he may decide to reduce his markup or negotiate a better rate with the US manufacturer. Clearly, fluctuations in international currency exchange rates make financial forecasting more difficult for globally operated companies.
The international currency exchange rate is an important determinant of the health of an economy, and is one of the most watched and analyzed macro factor on a global scale.