An exchange rate indicates how much your currency is worth in another currency. Consider it to be the cost of purchasing that currency. For example, in January 2022, one euro was equivalent to $1.13 US dollars, and one US dollar ​​was equal to 0.88 euros. Most currencies' exchange rates are determined by foreign currency merchants. They trade currencies around the clock, seven days a week. This market was worth more than $6.6 trillion each day in 2021.

There are two types of exchange rates.

Exchange rates are classified into two types: flexible and fixed. Flexible currency rates are continually changing, but fixed exchange rates are rarely changing.

Flexible

Flexible exchange rates are the kind most used in the world. They are the rates used in the foreign exchange market. They change based on supply and demand of the foreign currency and the currency being exchanged.

Fixed

Fixed exchange rates are set by the government of a country. The government agrees to exchange its currency for another in a fixed amount. Most countries have abandoned fixed exchange rates, but many developing countries still use them. This is because they make it easier for businesses to plan ahead.

The Chinese yuan was formerly a stable currency. The Chinese government is now gradually moving toward a flexible exchange rate. This means that it fluctuates less frequently than a flexible exchange rate but more frequently than a set exchange rate. As of January 21, 2022, one US dollar was worth around 6.36 Chinese yuan.[4] The US dollar has depreciated against the yuan since February 2003. At the time, one US dollar could be swapped for 8.28 yuan. The US dollar has depreciated because it can now purchase less yuan than it could 200 years ago.

What Affects Exchange Rates?

Currency exchange rates are influenced by interest rates, money supply, and financial stability. As a result of these variables, the demand for a country's currency is affected by what is going on in that country.

Interest rates

Interest rates are the amount of interest a country pays to borrow money. They are set by the government and are one of the main factors affecting currency exchange rates. A government may increase interest rates to encourage growth or to fight inflation. It may decrease them to reduce inflation or to encourage business growth.

Higher interest rates make borrowing money more expensive for a country, so less money will be borrowed. A country's money supply decreases when it borrows less money. This causes the exchange rate of the country's currency to fall.

Money supply

The money supply is the total amount of money circulating in a country. The US money supply is the total amount of money in the US economy. It includes cash and loans. It can be transferred from one person to another through a bank. The money supply is not the same as the stock market.

If the government issues too much money, there will be far too much of it chasing far too few goods. The prices of goods and services will rise as currency holders bid up the value of their currency. This leads to inflation. Hyperinflation occurs when much too much money is printed.

Financial Stability

The currency exchange rates of a country are influenced by its economic development and financial stability. Investors will purchase the country's goods and services if its economy is healthy and rising. They'll need more of their cash to do so. They will be less eager to invest in a nation if its financial stability appears to be in jeopardy. They want to know that if they own government bonds in that currency, they will be paid back.

How Forex Rates Affect You

The quick answer is that it all depends on who you are.

You are more likely to notice the currency rate when you travel abroad. When the pound is strong versus the dollar, for example, you will receive more dollars in exchange for your pounds. As a result, the stronger the pound, the lower the cost of purchasing goods overseas.

The same is true for items purchased in the UK imported from other countries. For example, when the pound strengthens, food and other imported goods become less expensive.

The currency rate has an impact on businesses as well. Many businesses purchase items from other countries (imports) and use them to manufacture goods in the United States. Because the pound is stronger, these imports are less expensive.

Other companies sell their products to people worldwide (exports). A rising pound makes these items more expensive for foreigners to purchase, perhaps resulting in decreased sales for UK exporters.

In general, those who purchase more than they sell overseas like it when the pound is strong. People who sell more than they purchase overseas usually favour it when the pound is weak.

How to Compare Rates Between FX Brokers

When you are comparing currency exchange rates and transaction fee rates, keep in mind that there is no one standard for these rates among FX and CFD brokers.

A common mistake beginners make is to look at the fee per trade rate. Comparable rates aren't always seen among FX brokers. For example, some brokers charge a commission on trades executed in the local currency of a client's account, while others charge a commission in the currency of their own accounts. This can make it more difficult to compare the fees and rates of FX brokers.

One of the best ways to compare currency exchange rates is to take a look at the exchange rate history. This can be a great way to determine the overall trend of a currency. Most currency exchange sites have a historical chart that can be used to compare the current currency exchange rate against the historical rate. It can help you determine if the currency is over-priced or under-priced.

The transaction size is another important rate to compare when you're looking at FX brokers. For example, not all brokers offer competitive rates on small transactions. Make sure a broker offers competitive rates on small transactions, especially if you are interested in trading small amounts regularly.

The cost of executing a trade is essential. However, fees are not the only thing you should consider. The quality of customer service, the trading platform, the convenience of opening an account is also essential to consider, and the types of assets available to trade are other essential factors.

The execution speed of a trade is an important consideration. You want to know that your FX broker can execute your trades quickly. This can help you to avoid losses due to slippage.

Top tips on how to get the best available exchange rates

1. Plan ahead

Avoid exchanging your money at the airport when going on holiday as it will cost you more than if you plan ahead. If you can't avoid it altogether, make sure you pre-order your travel money for collection at the airport to get a slightly better exchange rate.

2. Don't rely on your credit or debit card

Credit and debit cards charge you a foreign exchange fee, which is typically about 3%. When you pay for your holiday using your credit card, it often seems to be a great way to get the best exchange rate, but in reality, you pay an extra 3% on top of it, so in the long run, you lose out.

How can you prevent paying foreign transaction fees? Before travelling, do your homework and study the fine print on your bank and credit card accounts. Inquire with your bank about foreign transaction costs.

If you have time before your trip, you should consider opening a new account with a credit card that does not impose foreign transaction fees, especially if it is a decent travel reward credit card.

3. Be aware of your ATM fees and limits

Whether you need cash from an ATM in another country, discover if your bank has ATMs in your destination city—you may be able to avoid paying expensive ATM fees. Remember that your bank may charge you a fee if you use an out-of-network ATM. This is in addition to any local fees levied by the international ATM. The exchange rate obtained from a foreign ATM is likely to be a better overall value than that obtained from an airport kiosk, but ATM fees can mount up, so make sure you withdraw enough cash to cover the cost.

Before your vacation, contact your bank to inquire about your account's daily ATM withdrawal restrictions. If your daily withdrawal limit is presently set too low, consider requesting that it be increased so that you can withdraw what you need while travelling.

4. Opt to pay in the local currency

Some shops will let you pick whether you wish to pay in local currency or pounds.

This is not the case with every transaction. However, occasionally after swiping your card, the store may show you a screen with two options: pay in pounds equivalent or pay in the local currency amount.

If you find yourself in this scenario, always prefer to pay in the local currency. You will be charged an additional currency conversion fee if you opt to pay in dollars. You will also most likely receive a low exchange rate. The merchant's point of sale system may make it appear like paying in dollars rather than the local currency is a more convenient option, but it will ultimately cost you more. When using your card, just pay in local currency.

5. Consider using a forward contract

Consider utilising a currency forward contract to swap your money if you are purchasing a home in another country. This allows you to lock in a favourable exchange rate for up to two years, ensuring that you don't miss out if the FX market swings against you and that you know the amount you'll pay when the time comes to settle. This is also handy at other times when you need to stick to a budget, such as when starting a business overseas or organising a destination wedding. Please keep in mind that forward contracts may demand a deposit.

6. Take note of the timeframes.

Allow plenty of time if you need to exchange your money by a specified date. Instant transfers might be significantly more expensive than ones that take a few days. Being organised will also assist you in obtaining the best foreign exchange rate and avoiding unnecessary fees. Conveniently, most currency specialists provide their customers with speedy transfers and automatic recurring payments, so you can be confident that your transfer will arrive on time. You may also make payments yourself 24 hours a day, seven days a week, using a secure online platform, providing you with complete control.

7. Make use of International Banking Apps

If you frequently travel internationally, consider utilising an international banking app like TransferWise (formerly known as Wise), Revolut, or others to handle your money. These applications make it easy to move money between nations and maintain several currency accounts.

You can, for example, maintain some money in several currencies with multiple currency accounts. It's helpful if you often go to Canada or Mexico or spend your summer vacations in Spain. This allows you to escape the volatility of foreign conversion rates because you'll always have some cash on hand for your next trip.

8. Use a market order to get the right rate

Consider utilising a market order to ensure you obtain the desired pricing. Market orders enable you to select the currency exchange rate you want to use for your transaction, and they will execute automatically when your target rate is met. This relieves you from continually monitoring the markets and provides you peace of mind that you won't lose out on your perfect rate, allowing you to return to your hectic schedule without losing out.

Conclusion

If you were struggling to understand the foreign exchange market, we hope you now have a better idea of how it works. Exchange rates are important. They affect your business and personal life, as well as international trade. If you have any questions about exchange rates or would like to ask about FX and CFD broker comparisons, please leave a comment below.

Bound is a specialist foreign exchange hedging firm that offers currency protection for businesses.

We help companies that are at risk of losing money to changes in the exchange rate to protect themselves against these losses.

By using the services that Bound provides, UK companies of all sizes are able to conduct business in foreign currencies with complete certainty about the exchange rates that they will receive. Subscribe to our newsletter or watch a demo of our product today!