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What are Currency Exchange Rates?

About forty years ago, most of the world's currencies ceased having any backing to support their value. At one time, many currencies were backed by silver, gold, or other means – the governments that issued paper currency did so while maintaining some form of support for it.

This is no longer the case for most currencies. The value of a U.S. dollar, a ruble, a British pound, a Swedish kronor, a Brazilian real, and that of the vast majority (but not all) currencies, is determined by trading on the international foreign exchange market.

The international foreign exchange (forex) market operates from Sunday night to Friday night non-stop. It trades volumes of hundreds of trillions of dollars' worth of in value of most of the world's currencies (a significant exception is the Chinese RMB, however). As traders exchange dollars for rubles or Swiss francs or whatever currency they choose, they determine the value of these currencies.

As a result the exchange rate means just that: The rate obtained for exchanging one currency for another. This is why the rate is expressed in terms of currency pairs, and is written like this:

EUR/USD (euro/U.S. Dollar, or how many U.S. dollars you get for a single euro).

At the moment we're writing these lines, the EUR/USD rate is 1.366. This means that you will have to spend $1.366 (probably rounded up with a small commission for the broker to at least $1.37) to purchase a single euro.

Should you be using Mexican pesos to buy that same euro, you'll need 17.70 instead.

These rates change all the time, sometimes from one second to another, because the forex traders work in a global electronic market that functions at high speed.

The Currency Buying Rate and the Selling Rate

When you go to buy a foreign currency, you will see two prices listed for it: The Buying Rate and the Selling Rate (professionals call these the "bid" and "ask" price for the currency pair).

You are going to the bank or exchange broker to buy the foreign currency, so you must pay the Selling price (the 'ask' price) which is higher than the buying price. Like all merchants, brokers sell dear and buy cheap.

When you get back from your destination, you will have some foreign currency left over to sell back to the bank or broker. You will sell it at the Buying Rate ("bid" price) which is always shown before the Selling Price, and which is always lower.

How do Traders Determine the Currency Rates?

There are no rules obliging traders to trade for currencies in any specific way. It's up to them. Anyone can become a trader, just by creating an account with forex broker, and there are millions. But it is the really big banks and brokerages, with the most money online, that have the greatest influence on how exchange rates are determined, and these houses proceed according to some basic guidelines.

A currency increases in value when the interest rate imposed by the central bank which issues that currency goes up. This is a certainty, because a higher interest rate means that banks must pay more to obtain the currency, and so it become scarcer. Traders thus react by pushing its value higher.

Traders also push up the value of a currency when the economy behind it – usually that of a single country, but in some cases more than one (the euro) – improves or grows. When the government makes the announcement, for example, that gross domestic product in the last quarter was up 3 percent, the value of the country's currency usually improves as well on the forex market. Similarly, bad economic news will pressure the value of a country's currency lower.

If you are travelling to a country, it's best to look on the Internet and to see how its economy and its currency are doing before you decide to exchange your own currency for that of where you're headed. Find out what to expect: If that country has a very strong currency, you will know that the buying power of your own may be weak at your destination. If the currency is weak, you might plan to make some extra purchases.

It is often better to buy the currency of your destination at a bank at home before you travel. You can often shop around for a good exchange rate, and then order the money in advance. Usually, arriving at your destination and going to an exchange booth will offer you a relatively poor rate of exchange.

The currency calculator permits you to determine how much you will receive in foreign currency in exchange for you own. Input the exchange rate and the amount you wish to exchange. If you do not know the rate, use the link to look up the exchange rate.