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What are currency exchange rates and how are they determined? 

What are currency exchange rates and how are they determined? 

May 21, 2024 7 min read

When sending money to a loved one or friend in another country, you may have thought about the exchange rate. This important piece of information will determine just how much you need to send so that the receiver gets the amount they need.

So, just how are exchange rates determined? And what can you do to get the best rate? Read on to understand exchange rates and how they help you make the most of your money.

What Are Exchange Rates?

A currency exchange rate is the rate at which you can trade one type of currency for another. It’s typically between two currencies of different countries. The exchange rate can be further broken down into the nominal exchange rate and the real exchange rate.

Nominal Exchange Rate

The nominal exchange rate is the formal rate of exchange between two types of currency. For example, if it takes $1.25 to buy one euro, the exchange rate is 1.25 to 1. It’s the number most people consider when sending U.S. dollars to Mexico, for example, to be turned into pesos.

Real Exchange Rate

Another type of exchange rate to consider is the real exchange rate (RER). While this isn’t typically given when trading in currency, it has a big effect on how far your money will go. It measures how far one type of currency will go in buying things in another country.

For example, if the $1.25 mentioned above can be turned into one euro, that’s just part of the story. How many euros do you need to buy a slice of pizza? Let’s suppose that it costs USD 3 to buy a slice, but over 9 euros to buy the same slice in Germany. To figure out the real exchange rate (RER), we could use the following formula:

e (nominal exchange rate) x P* (average price in Germany) / P (average price in the U.S.)

So, in this case, the RER would be $1.25 x $9 / 3 euros, or $3.75. 

That’s a big difference and a sign that, despite the exchange rate, your American dollars won’t go as far in a country that accepts euros. 

Consumers should consider both the nominal exchange rate and the real exchange rate when choosing what currency to convert to. While you don’t always have a choice, knowing the true value can help make your money go further.

Bitcoin Exchange Rate

There’s also the matter of Bitcoin and other cryptocurrencies, which have their own system for determining the exchange rate. Since they are independent of many of the factors used for international currencies, you can’t often know how they will convert without checking each currency’s current value.

Bitcoin’s price is usually labeled in U.S. dollars, and you can see what the current value is at most cryptocurrency exchanges.

How Exchange Rates Work

Exchange rates are simply a conversion rate from one currency to another. It works by providing the amount you’ll need for one to get a certain amount of the second. If the exchange rate is poor, you may lose a lot of the value of your money before it is turned into another currency. If the exchange rate is good, your money can go a lot further in another country.

Factors That Affect Exchange Rates

We know that the exchange rate tells you how many euros you can get with a dollar, for instance, but what determines the rate? There’s no single factor, and the following play influential roles in how it all plays out:

  • The floating exchange rate — the most common type of exchange rate — goes up or down depending on how many people want to invest in it or use it. It’s controlled by supply and demand.
  • Fixed exchange rates get tied to another country’s currency, most commonly, the U.S. dollar. When the dollar goes up, so does the other country’s money, and vice versa.
  • Spot rates are real-time exchange rates, or the price you would pay at this very second for another currency. 
  • Forward rates, on the other hand, get set in advance and are based on what the economy might look like in the future.

Finally, the economy also plays a vital role Important details like interest rates or political stability can trigger investors to want to buy more of a currency (which can send the rate higher). These factors are included in general supply and demand but can also include outside influences like a country’s debt rating or ability to pay its bills.

What does all this mean? Exchange rates can and will change frequently for many reasons. It’s best to find the best exchange rate when possible and be prepared for it to go much higher or lower as world events occur.

How Exchange Rates Impact International Money Transfers

The exchange rate is an important part of what you’ll pay to send $20, $200, or even $2,000 to a friend in another country. When the currency exchange is weak, you’ll have to send more money for that same $20. When the exchange is strong, you can send the same amount and watch it go further.

Exchange rates make a big difference for someone receiving money, too. If the sender sends the same amount from their paycheck every week, it may not make the same difference as the rate changes. Sending $20 to Canada may not pay for a dinner out one week but could more than cover a meal and dessert the next.

If there is a particularly good rate, and the sender can afford it, they may choose to send a bit more than normal to take full advantage. Likewise, if someone is supposed to receive money, but the rate is poor, they may ask their friend to choose another day to send the cash in hopes the rate may improve.

How to Check the Exchange Rate

There are many ways to see how much you can get with your money, including doing a Google search or checking with your bank. You can easily see how much your money will convert to another currency and decide if it’s a good time to send or receive.

If you plan on sending an international money transfer anyway, you might consider using Ria Money Transfer’s app to check rates in real time. Just enter the sending and receiving countries, as well as the dollar amount you want to send. Pick how you will fund the transfer (credit card, debit card, or bank account). Then, specify how the receiver will want to get their funds.

You can see from the app how much money will go to your friend or family member, as the exchange rate is included in the quote. This makes it easy to adjust how much you send to ensure you are sending enough to meet the receiver’s needs. With Ria’s low fees, you can also see that you usually get more with your money than you would with third-party money orders or wire transfer services.

How to Use Money Transfers to Get a Good Exchange Rate

Exchange rates aren’t just important for sending or receiving money. They also matter when you travel. While you can use most credit or debit cards overseas, they will pay for goods in the currency of the country you are visiting. In other words, they are subject to the exchange rate.

Not only this, but you may pay foreign transaction fees for card purchases, which add to the cost of your purchases. If you withdraw cash from a foreign ATM, there are often fees for that, too. These fees can add up and keep you from getting the most from your money.

Rather than pay high card fees, some travelers prefer to use money transfer apps to send money from one currency to another. For instance, they can send it to a friend where they will be traveling or even to themselves. Ria’s fees can be much lower than what cards charge, making this a great way to get more out of your money.

Example: Exchange Rates in Action

Using today’s rates and the Ria Money Transfer App, here are examples of what you can send or receive in different currencies.

  • U.S. to Brazil: 1 USD = 5.15897 BRL
  • U.S. to Mexico: 1 USD = 17.11471 MXN
  • U.S. to Albania: 1 USD = 93.95264 ALL

Ria allows you to send to over 500,000 pickup locations in over 190 countries. It’s a convenient way to transfer money at great exchange rates.

Next Steps for the Best Exchange Rate

Knowing the exchange rate for your preferred currency is just the start. It’s also important to use money transfer services that don’t take too many fees or give you a poor or outdated exchange rate. By using an app you can trust, such as Ria Money Transfer, you can send and receive money securely in as little as 15 minutes and at the day’s current rate.

About the author

Michael Hoffman

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