Exchange Rate

What Is an Exchange Rate?

An exchange rate is the value of one country's currency relative to another's. It tells you how many units of a foreign currency you can get for one unit of your own. For example, if one U.S. dollar buys 0.90 euros, the exchange rate is 0.90 euros per dollar. Exchange rates let people and businesses convert money when they travel, buy goods from other countries, invest abroad, or send payments across borders.

How It Works

Exchange rates are quoted as pairs, such as USD/EUR or USD/JPY. The first currency is the base, and the second is the quote currency. Most major currencies trade in the foreign exchange (forex) market, where banks, funds, companies, and individuals buy and sell currencies continuously. Rates are set mainly by supply and demand. When demand for a currency rises, its value usually rises against others. Factors that influence this demand include interest rate differences between countries, inflation, economic growth, trade balances, and investor confidence.

Exchange rates can be floating, meaning they change freely with market forces, or fixed, meaning a government or central bank keeps the rate near a set level. Many large economies use floating rates, while some smaller economies peg their currency to another, such as the U.S. dollar.

Why It Matters to Investors

Exchange rates affect the returns on foreign investments. If you own shares of a company listed in another country, a gain in the stock can be partly offset or increased by a change in the currency's value when you convert the proceeds back to your home currency. Exchange rates also affect multinational companies, since their overseas sales and profits must be translated into their reporting currency. A strengthening domestic currency can make exports more expensive for foreign buyers and imports cheaper for local consumers, which can shift the earnings outlook for different industries.