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The exchange rate is the value of one country’s currency exchanged for another. Find out how exchange rates are calculated, what affects the change and where to find the best rates.
Foreign exchange rates are calculated based on the currency values of the two currencies being exchanged. Take an example of the Canadian dollar and the Australian dollar. If 1 CAD equals 1.44 AUD, this means you will receive 1.44 Australian dollars for every 1 Canadian dollar.
The same will apply if you want to know how many Canadian dollars you can purchase with 1 Australian dollar. With an exchange rate of 1 AUD = 0.7142 CAD, you will get 0.7142 US dollars in exchange for 1 Australian dollar.
With these examples, if you transfer 100 Australian dollars to Canada, the recipient will receive $71.42 CAD (100 x 0.7142). And when transferring 100 Canadian dollars to Australia, your recipient will receive $144 CAD (100 x 1.44).
Foreign exchange rates can rise and fall. If a currency increases in value, it’s said to have strengthened — meaning the currency will be exchanged for more against another currency. For example, if 1 AUD was being exchanged for 0.7142 CAD in July and it changes to 0.9381 CAD in October, the Australian dollar is said to have strengthened against the Canadian dollar.
If a currency falls in value, it’s said to have weakened — meaning it will be exchanged for less against another currency. For example, if 1 AUD was being exchanged for 0.9381 CAD in October and changes to 0.6514 CAD in November, then the Australian dollar is said to have weakened against the Canadian dollar.
Knowing the value of your currency in relation to foreign currencies will help you analyze investments priced in foreign currencies. For instance, for an Canadian investor, knowing the CAD to USD relation is important if he or she is looking to buy property in the States. The exchange rate is also useful to know for other reasons:
A solid exchange rate is crucial. When it comes to larger amounts, even two cents can save — or cost you — hundreds. If you have the luxury of time, you may be able to take advantage of a limit order, which allows you to set a target exchange rate with a service or broker that they market 24/7 to ensure you don’t miss that target. Some services, like OFX money transfers, offer free limit orders for transfers of $35,000 and more.
How important is the exchange rate? Say you need to get 500,000 euros to a broker in Spain for a down payment on a pied-à-terre or similar piece of real estate. The mid-market rate for dollars to euros is 1 CAD = 0.65 EUR. You’re happy to find two online services that are pretty close to the mid-market rate — one is offering 0.63 for your dollar and the other 0.62. But to be sure which is the better deal, you crunch the numbers.
|Service A||Service B|
|Exchange rate||1 CAD = 0.63 EUR||1 CAD = 0.62 EUR|
|Inverse exchange rate||1 EUR = 1.587 CAD||1 EUR = 1.613 CAD|
|500,000 euros in dollars||$793,500||$806,500|
Finding the inverse exchange rate, you learn that the exchange rates are a mere 3 cent difference (0.026 cents, to be exact). Yet, when applying these rates to converting 500,000 euros to Canadian dollars, you’d lose $13,000 to the first money transfer service on the exchange rate alone. That’s a lot of rioja you could be sipping in Madrid.
The rate you receive is lower because the rates you see on the evening news or on a business news website is the “interbank rate.” This is a rate used between banks when they buy and sell currency among themselves. The rate you receive will have a margin built into it, or other fees, which makes it less competitive than the interbank rate.
As a consumer, the rate you get will also depend on where you exchange your money. Providers like banks, currency exchange kiosks and PayPal traditionally offer poorer exchange rates when compared to currency exchange services like OFX and TorFx. Compare rates thoroughly before carrying out an exchange.
When transferring funds internationally or exchanging currency for a trip overseas, you want to get the most bang for your buck. A few ways to get the best exchange rate possible:
Some of the major banks don’t provide live exchange rate data unless you’re an account holder. However, we found the data for TD Canada Trust, RBC, HSBC and EQ Bank to compare their rates.
Of those four, EQ Bank had the strongest foreign currency exchange rates as of October 30, 2020. Comparing the rates for CAD-USD, CAD-PHP and CAD-EUR, average mid-market markups were:
The higher the percentage, the more expensive your transfer. More favorable exchange rates can be found by comparing money transfer providers instead of sticking with the bank.
Exchange rates can be either flexible or fixed.
Flexible exchange rates are determined by the foreign exchange market, commonly known as the forex market. Flexible exchange rates change throughout the day depending on what traders think the currency is worth along with other factors. Flexible exchange rates are said to be “floating” and can fluctuate regularly due to many factors.
A fixed, or pegged, rate is where a currency’s value is maintained against another by its government. In this case, a government will set a price against a major currency like the euro, Japanese yen or U.S. dollar. To maintain this rate, they’ll need to reserve an amount of this foreign currency. If demand for this currency drives the exchange rate up, they’ll need to release more of this foreign currency into the market to meet the demand. And if demand is low, they’ll have to do the opposite and buy this currency.
As many will quickly point out, the majority of exchange rates aren’t purely floating or purely pegged. Most pegged rate systems will rely on a floated currency, so they’re really using a “floating peg” system. And most floating currencies are influenced by their government’s economic policies, such as tax cuts.
Exchange rates are some of the major determinants of a country’s economic performance. This is because countries depend on foreign trade with other countries across the world to sustain their economy. For example, Canada’s economy cannot be stable without trading with the U.S., Africa, China and the U.K., among other countries. So exchange rates will affect both imports and exports, and in turn influence the balance of trade of a country.
Aside from demand and supply being the main determinants of foreign exchange, there are a number of underlying factors — both geopolitical and economic – that affect the exchange rate. Some of the most common include:
Interest rates charged by the central bank in a particular country will affect the currency value of that country. A country whose central bank has higher interest rates will give lenders higher returns, and this tends to attract foreign investors. As a result, the exchange rate will increase. Consequently, higher interest rates will increase the exchange rate of a country, mainly when other factors of the economy remain stable and the interest rate is the major factor to influence the economy.
For example, if the Bank of Canada is offering high interest rates, investors from foreign countries such as the U.K. and U.S. are likely to be attracted to invest in Canada. As a result, the exchange rates for the Canadian dollar will rise due to the increased demand.
The terms of trade of a country are determined by the balance between exports and imports. If the prices of exports from a country rise more than those of its imports, the terms of trade in that particular country will be greatly improved. This basically means that the country’s exports are in high demand. The final results will be that the country will receive more revenue from its exports and its currency will also be in high demand, leading to an increase in the currency’s value.
The reverse will happen if the country’s export prices rise by a smaller rate than that of its imports. The demand for exports will be low and the country will be importing more than its exports. This will decrease its currency’s demand and value.
So if Canada is exporting more goods to foreign countries, its currency is likely to be in high demand and foreign exchange rates will be higher.
A country with lower inflation rates will have a high currency value because its purchasing power increases in comparison with other countries. Consequently, when a country is affected by the ongoing worldwide economic crises, its inflation will increase. This will reduce the country’s purchasing power, depreciate its currency exchange rates and its trading partners will perform better than it.
Countries with relatively low inflation rates such as Canada, the U.S., Germany, Japan, Switzerland and Australia normally have high purchasing power and their currency values do not depreciate much.
No investor will take the risk of investing in a country that is politically unstable. Investors will look for countries with a stable political climate so their capital is safely invested. Generally, countries with a stable political climate will have strong economic performance and will attract more investors.
Consequently, an unstable political climate will cause a loss of confidence in a country’s currency and this will lower its exchange rate.
A country with high public debt is likely to welcome inflation, and this may mean the country will have to do everything possible to pay off the debt, even if it means printing money for that purpose. When this happens, the currency value of that particular country will be reduced and this will lower its exchange rate.
Consequently, a country with high public debt will lower its currency exchange rate and this will not attract foreigner investors because their investment will be at risk.
In general, fluctuating rates affect a range of stakeholders, including:
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