In this lesson summary review and remind yourself of the key terms and calculations related to exchange rates.
Lesson summary
If someone from Hamsterville came up to you and tried to buy an old book from you, and tried to pay you in their currency — the Hamsterville snark () — you’d tell them “no thanks!”
Why? Because the Hamsterville snark is worthless to you since you can’t buy anything with it in your country. Instead, you want to be paid in your own currency. That means that someone from Hamsterville would need to exchange their currency for the currency used in your country.
The exchange rate of a currency is how much of one currency can be bought for each unit of another currency. A currency appreciates if it takes more of another currency to buy it, and depreciates if it takes less of another currency to buy it.
Key terms
| Key term | Definition |
|---|
| exchange rate | the price of one currency in terms of another currency; for example, if the exchange rate for the euro (€) is yen (¥), that means that each Euro that is purchased will cost yen. |
| appreciate | when a currency becomes more valuable relative to another currency; a currency appreciates when you need more of another currency to buy a single unit of a currency. |
| depreciate | when the value of a currency decreases relative to another currency; a currency depreciates when you need less of another currency to buy a single unit of a currency. |
| floating exchange rates | when the exchange rates of currencies are determined in free markets by the interaction of supply and demand |
Key takeaways
The exchange rate is the price of one currency in terms of the other
Currencies are traded in the foreign exchange market. Like any other market, when something is exchanged there is a price. In the foreign exchange market, a currency is being bought and sold, and the price of that currency is given in some other currency. That price is expressed as an exchange rate.
For example, in the market for the Hamsterville snark, the exchange rate of the snark to the U.S. dollar () is per snark. That means in order to buy a single snark, someone from the United States would need to pay for it with .
On the other hand, someone from Hamsterville who wants dollars would buy those dollars with snarks. So, the exchange rate of the dollar is the inverse of the exchange rate of the snark:
Sophie is a reporter for the Hamsterville Courier News and is preparing an article on the exchange rates for three of Hamsterville’s primary trading partners. Unfortunately, she spilled her lime smoothie on her notes and some of the entries in the table she created are missing. Help her out by completing the missing entries in the table below:
| Hamsterville snark () | Galactic credits () | Canadian dollar () |
|---|
| 1 Hamsterville snark (SN) is exchanged for | 1 | 10 | 2 |
| 1 Galactic credit (GC) is exchanged for | | 1 | .2 |
| 1 Canadian dollar () is exchanged for | | | 1 |
Solution:Remember that the exchange rates of any two currencies are inverses of each other. So, if the exchange rate for the Hamsterville snark (SN) is:
Then the inverse of that exchange rate is the exchange rate for the galactic credit (GC):
| Hamsterville snark () | Galactic credits () | Canadian dollar () |
|---|
| 1 Hamsterville snark (SN) is exchanged for | 1 | 10 | 2 |
| 1 Galactic credit (GC) is exchanged for | .1 | 1 | .2 |
| 1 Canadian dollar () is exchanged for | 0.5 | 5 | 1 |
If a currency appreciates it is more valuable; if a currency depreciates it is less valuable
When an exchange rate changes, the value of one currency will go up while the value of the other currency will go down. When the value of a currency increases, it is said to have appreciated. On the other hand, when the value of a currency decreases, it is said to have depreciated.
For example, if it now takes to buy a single Hamsterville snark instead of , the snark has appreciated and its value has increased. If prices in the United States haven’t changed, this is great news for Hamstervillians! Now the snark can buy more goods and services from the United States.
But, this is bad news for Americans who want to buy Hamsterville’s goods and services. Each U.S. dollar now buys only instead of as it did before. The dollar has depreciated against the snark and everything from Hamsterville just got a lot more expensive.
Key equations
Exchange rates
The exchange rate of a currency is expressed as the units of another currency needed to buy a single unit of the currency. For example, the exchange rate for currency A is given below:
Calculating the cost of something with exchange rates
To find the cost of something in the value of another currency, divide that cost by the exchange rate. For example, it takes 300 galactic credits () to buy a smoothie on Tatooine. If the exchange rate means that buys , then the cost of a Tatooine smoothie to a Canadian tourist is:
Therefore a Tatooine smoothie costs to a Canadian.
Common misperceptions
We are used to thinking about buying things with a currency, so many new learners are confused about what the price should be in the market for a currency. But the price of an orange is never given in oranges; it’s given in some other currency. Just like an orange, a dollar can’t be bought with itself, but instead, it needs to be bought with some other currency.
A common misperception is that a strong currency is always what is best for a country. On the one hand, if a currency appreciates, all of its imported goods get a lot cheaper. If a country tends to import a lot more goods than they export, then an appreciated currency might be desirable. But on the other hand, if a country relies heavily on exports, an appreciating currency isn’t such a great thing. When a currency appreciates, the exports from a country that use that currency will decrease because all of those goods are more expensive to countries other currencies.
Questions for review
The Ghanaian cedi currently trades for 20 Icelandic kroné.
- What is the exchange rate of the kroné? What is the exchange rate for the cedi? SHOW YOUR WORK.
- If the trading price changes to 25 kroné per cedi, what has happened to:
- If the cost of a fermented shark sandwich in Iceland is 1500 kroné, what is its cost in cedi to a tourist from Ghana based on a trading price of 1 cedi for 20 kroné? Show your work.
ééé
Remember that exchange rates are always expressed as the amount needed to buy a single unit of the currency described.
é
If the trading price changes to 1 cedi for 25 kroneThe kroné has depreciated. A single cedi can now buy more kroné, so the kroné is cheaper.
b. The cedi has appreciated. A single cedi can buy more of the other currency (the kroné), so the cedi is more valuable.
You need 75 cedi to buy a shark sandwich.
FAQs
The exchange rate of a currency is how much of one currency can be bought for each unit of another currency. A currency appreciates if it takes more of another currency to buy it, and depreciates if it takes less of another currency to buy it.
How many US dollars have the same value as Euro Khan Academy? ›
You would essentially just divide both sides by 0.87. If you divide this by 0.87 you get one. If you divide one by 0.87, you are going to get approximately 1.15. And so at the time of this video, 1.15 U.S. dollars is equal to one Euro.
What do you mean by currency exchange? ›
A currency exchange is a licensed business that allows customers to exchange one currency for another. Currency exchange of physical money (coins and paper bills) is usually done over the counter at a teller station, which can be found in various places such as airports, banks, hotels, and resorts.
What is the foreign exchange market in economics? ›
The foreign exchange market (FX market) is where participants come to buy and sell foreign currencies (e.g., foreign exchange rates, currencies, etc.). Foreign exchange trading occurs around the clock and throughout all global markets.
What is the foreign exchange model in macroeconomics? ›
What the foreign exchange model illustrates. Exchange rates are determined by the interaction of people who want to trade in their currency (the supply of a currency) with other people who want to obtain that currency (the demand for a currency). The foreign exchange model is a variation on a market model.
How many US dollars have the same value as 1 euro? ›
1 EUR = 1.09165 USD Aug 03, 2024 03:43 UTC
The currency converter below is easy to use and the currency rates are updated frequently.
How much is $1 euro compared to us? ›
Cross Currency Rates Calculation
| EUR | USD |
|---|
| EUR | 1 | 1.0835 |
| USD | 0.9229 | 1 |
| GBP | 1.1765 | 1.2747 |
| CHF | 1.0601 | 1.1486 |
3 more rowsAn exchange rate is a relative price of one currency expressed in terms of another currency (or group of currencies).
How to understand exchange rates? ›
The exchange rate gives the relative value of one currency against another currency. An exchange rate GBP/USD of two, for example, indicates that one pound will buy two U.S. dollars.
What is the theory of the exchange rate? ›
Demand and Supply Theory of Exchange Rate Determination
Any increase in demand, barring any change in supply, will lead to the appreciation in currency value. Conversely, the supply of a currency into the foreign exchange market could come from foreign investors, tourists, importers, or governments.
It reinforces America's economic dominance and it helps reduce inflation by making imports cheaper. But a rising dollar doesn't lift all boats. Some exporters have been hit as the stronger domestic currency makes them less competitive in overseas markets, while also creating economic headaches around the world.
Is every currency pegged to the dollar? ›
Over 66 countries have their currencies pegged to the US dollar. For instance, most Caribbean nations, such as the Bahamas, Bermuda and Barbados, peg their currencies to the dollar because tourism, which is their main source of income, is mostly conducted in US dollars.
Why would another country want to peg its currency to the US dollar? ›
Countries that peg their currency to the dollar do so because the U.S. dollar is the world's reserve currency and is relatively strong in the international market. As such, transactions and any international trade that takes place often happens in U.S. dollars. This helps keep a country's pegged currency stable.
What is foreign exchange in simple words? ›
Foreign exchange refers to exchanging the currency of one country for another at prevailing exchange rates.
Why is foreign exchange important to the economy? ›
Foreign exchange markets serve an important function in society and the global economy. They allow for currency conversions, facilitating global trade (across borders), which can include investments, the exchange of goods and services, and financial transactions.
What is the theory of exchange in economics? ›
Exchange Rate Theories seek to explain how and why exchange rates between currencies change over time. Some major Exchange Rate Theories are stated below. Purchasing Power Parity Theory - This argues that exchange rates are determined by relative price levels and inflation rates in different economies.
Are euros and dollars worth the same? ›
The dollar is almost equal in value to the euro. Here are the upsides and downsides. The euro is now worth slightly less than $1.02.
How much is the US dollar worth compared to other countries? ›
US Dollar Exchange Rates Table Converter
| US Dollar | 1.00 USD | inv. 1.00 USD |
|---|
| Euro | 0.924796 | 1.081319 |
| British Pound | 0.781060 | 1.280312 |
| Indian Rupee | 83.714033 | 0.011945 |
| Australian Dollar | 1.531538 | 0.652938 |
6 more rowsCalculate it Manually
To do this, you need to know the current exchange rate for US dollars to euros, which you can look up online. At the time of writing, $1 USD is equivalent to €0.95 EUR. Once you have that information in hand, multiply the amount you have in USD by the current exchange rate.
