How Does Currency Exchange Work?

Learning how currency exchange works can be useful for individuals who wish to send money overseas. The truth is that many people have misconceptions about how it works. Hence, this post will try to clear any misinformation and make it easy for you to understand the currency exchange concept. Let’s start with the basics:

The exchange rate

Let’s say you are planning to exchange a few US dollars for some British Pounds, but you wonder why you are getting lesser British Pounds for each American dollar that you change. If so, you have just experience exchange rates in action. You see, each country has their own way of determining the value of a product or service – whether it is for tourism, investment or foreign trade. The exchange rate is simply one form of currency’s value represented in another form of currency’s value. The new currency is usually calculated from the multiplication of your own currency with the most recent exchange rate. Simply put, you have also just purchased a different form of money.

What determines a currency exchange’s rate?

This process involves many entities such as fixed peg, currency board, fixed exchange rates, crawling peg, managed float, targeted exchange rate and exchange rate regimes. In the past, governments around the world implemented the gold standards system as a way to formalize exchange rates.

Under the system, all currency represented a certain amount of gold that is stored held in a vault by that government. However, as time went by, the system was flawed due to limited amount of space and the impracticality of keeping up with large gold reserves and the volatile nature of currency’s supply and demand.

Nowadays, there are just three major systems that determine a currency’s exchange rate. First is the fixed exchange rate system which involves government intervention to maintain a fixed exchange rate. Second is the flexible or floating exchange rate system where supply and demand determines the exchange rate. The third is the managed exchange rate system where rates are allowed to float but will be subjected to government intervention when there are sudden fluctuations.

Currency exchange rates do not stay the same every day

Basically, a currency is worth on whatever sum people are willing to fork out to exchange and the rate will be affected on a day to day basis. Like most things in our economy, a currency’s worth is determined by supply and demand. This can be caused by changes in trade through exports and imports. Price levels, interest rates and political situations in a country are also determining factors on how the currency exchange will work from one country to another.

For instance, a government might be borrowing on currency value and decides to cut taxes but not its budget. Now it has to finance this budget by borrowing more, causing interest rates to increase. These economical forces are simply uncontrollable by the general population but it certainly is how the “ups and downs” in currency exchange happens.

If you want to send a money remittance from the US to your home country and worry about how currency rates can lessen the amount of funds your loved ones actually get, then you can try Sharemoney’s money transfer services. We offer competitive currency exchange rates for all our money transfer services so that you get more value for every dollar you transfer back home!