In short, the exchange rate describes the relationship between two currencies and is determined on the basis of the smallest currency unit, a euro or a US dollar. However, exchange rates are divided into two groups. On the one hand the exchange rate is determined, on the other hand, derived from it, the sort rate.
- The determination of the exchange rate for the euro is announced by the European Central Bank on every trading day.
- The exchange rate is the exchange rate on which real money is exchanged for another currency.
- The exchange rate of a currency depends, among other things, on the stability of the respective economy.
The exchange rate
Short for XRT by abbreviationfinder, the exchange rate refers to book money, i.e. foreign exchange transactions that are cashless. Foreign exchange trading is the world’s largest marketplace with an average transaction volume of US $ 5.3 trillion per day (as of spring 2014). The determination of the exchange rate for the euro is announced by the European Central Bank on every trading day. The basis is the reporting of the middle rates from 17 credit institutions to the ECB at around 1 p.m. The respectively valid average values are calculated from this. Exchange rates fundamentally differentiate between the bid and the ask rate, which reflect the price that the seller receives for the currency or that the buyer has to pay. Foreign exchange trading requires that one currency can be freely traded, which is not the case for all currencies, for example the Chinese yuan.
The variety course
The currency exchange rate is the exchange rate on which real money is exchanged for another currency, i.e. the rate that is calculated at the bank counter or in an exchange office. The currency exchange rate is derived from the difference between the mean value and the ask or bid rate of a currency, but leaves banks and exchange offices still leeway. For example, the US dollar is quoted in forex trading with a bid rate of 1.30 and an ask rate of 1.32. The mean value is 1.31, so the bid price for varieties would be 1.35 and the ask price for varieties would be 1.315.
Economic significance of exchange rates
The exchange rate of a currency depends, among other things, on the stability of the respective economy. The real exchange rate reflects the value at which an underlying basket of goods in one economy can be exchanged for an identical basket of goods in another economy. From this it can be deduced in which country a product can be bought at a lower price. A reference date on which this comparison is made is not very meaningful. More information about the development of one currency area in comparison to another is given by looking at it over a longer period of time. This shows how the exchange rate of the two selected currencies relates to one another. Strong fluctuations are due, among other things, to the economic development in a currency area, but also due to the monetary policy decisions of the respective central bank. For example, if the interest rate rises in the US, more investors will invest in US bonds, the demand for US dollars increases, and the dollar becomes more expensive compared to the euro.
Change in exchange rates
The example of rising interest rates in the USA makes it clear that the rate of one currency changes compared to another due to supply and demand. As mentioned earlier, the forex market is the largest marketplace in the world. This is the reason for the tremendous liquidity that is available in this market, which in turn leads to strong fluctuations in price formation. This means that foreign currencies are in the focus of speculative investors who hope for short-term profits and who sometimes contribute to a falsification of the actual value of a currency, the real value of the underlying basket of goods, through speculative transactions.
Exchange rate risks
German investors who invested in high-yield South African rand bonds at the beginning of the 1990s did not enjoy the return when they redeemed the paper. By the mid-1990s, the rand had lost almost 30 percent against the D-Mark. When the investment funds were redeemed and reconverted from Rand to D-Mark, the return was completely lost due to this depreciation of the foreign currency. The result was massive losses on the part of German investors. Anyone who invests money in foreign currency bonds must take the exchange rate into account. In addition to the risk of a currency loss, on the other hand, this naturally also offers the opportunity of realizing an above-average return abroad as well as exchange rate gains via the currency.