How to calculate exchange rates

If you ever send money abroad, or travel overseas, it’s important that you understand how a country’s local currency relates to the money you have.

The ‘exchange rate’ refers to how much of one currency you can get for another country’s. For example, you could get about 1 USD for 0.83 EUR. Or, in other words, 1 EUR is equal to about 1.21 USD.

Exchange rates fluctuate constantly throughout the week, as currencies are actively traded. Prices go up and down, similar to other assets such as gold or stocks. But it’s important to know that the market price of a currency is different from the rate you will receive from your bank when you exchange your money.

Knowing how to calculate exchange rates will ensure that you’re getting the best deal possible when you come to exchange your money. That’s where companies like WorldRemit can help. Here’s a useful guide on how to check and calculate exchange rates.

How are exchange rates calculated?

Exchange rates around the world are determined by foreign exchange trading (FX), an international market for buying and selling currencies.

Forex trading includes small transactions, such as those made by individuals exchanging their holiday money. It also includes larger transactions, such as those made by businesses securing an exchange rate for the future. This Forex trading is always on – all day, every day – that’s why exchange rates are constantly changing.

These trades impact exchange rates because there’s more money circulating in different economies. Since about 88% of the world trade is in US dollars, most exchange rate calculations are compared to this currency.

How do banks calculate exchange rates?

The market price of a currency is different than the rate the banks set for their exchange rates. Banks calculate their exchange rates based on a number of factors, including: market conditions, competitive exchange rates, their desired rate of return, market risk, credit risk and other economic and business factors. Because of this, their foreign exchange rates are also constantly changing.

It’s worth looking at a number of banks’ exchange rates, as they may not compare that favourably to other providers like WorldRemit. And as well as having specific exchange rates, banks might charge additional fees when it comes to international bank transfer – so it’s worth considering this before choosing a transfer provider, too.

Different types of exchanges rates

How foreign exchange rates are set and calculated depends on a number of different factors; including what type of exchange rate it is. The difference between a floating and a fixed exchange rate will really determine how currency prices are determined.

Floating exchange rates

Floating rates are all about supply and demand. So, how much demand there is in relation to the supply of a currency will determine that currency’s value in relation to another currency. The more US dollars wanted by Europeans, the greater the price of US dollars in relation to the euro.

Many geopolitical and economic factors affect the exchange rates between two countries, including: interest rate changes, unemployment rates, inflation reports, gross domestic product numbers, manufacturing data, and commodities.

Fixed exchange rate

A fixed or pegged exchange rate is set by the government through its central bank. It will be set against another major world currency (US dollar, euro, or yen). To maintain its exchange rate, governments will buy and sell their own currency to which it’s pegged.

Government intervention

With floating exchange rates, supply will occasionally outstrip demand, and so the currency will fall. Demand can also outstrip supply, in which case the currency will rise.

A nation’s economy can really be negatively affected when a currency is too high or too low. So, the government or central bank will then step in and attempt to implement measures to move their currency to a more favourable price.

How to find exchange rates

Foreign exchange rates are available on a variety of websites, such as those belonging to financial news publications, banks, foreign exchange providers and the google market exchange rate. These sites display easy-to-view numerical relationships between each currency. Many of them also have currency converters.

It’s extremely important to find reputable sources for accurate and up-to-date exchange rates. For example, if you want to send money abroad you can go to WorldRemit’s calculator on their website or app. Then, once you have signed up to their service, you can:

1. Choose the country you want to send to
2. Select how your family and friends will receive the money
3. Enter the amount you want to send – and you’ll immediately see the exchange rate they’re offering.

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You can also go to their app and set up alerts for real-time exchange rates. Here’s how:

1. Log in to the WorldRemit app
2. Go to Account > Settings > Notifications
3. For daily exchange rate notifications: tap the ‘Add’ button to choose which countries to receive notifications for (maximum of 3 countries)

Download the app

How to read exchange rates

When changing money to travel abroad, or sending money, it’s important to be able to read the exchange rate, so you know that you’re getting a good deal. Thankfully, it’s really quite simple.

All currencies are quoted in pairs like this: USD/CAD. The currency on the left (USD) is the base currency, while the one on the right (CAD) is the quoted currency. The base currency is always fixed at one unit, while the quoted currency is the equivalent of one base unit when traded into the other currency.

In this case you will need to sell 1.26 CAD to buy 1.00 USD. On the other hand, you will get 1.00 USD when you sell your 1.26 CAD.

Indirect versus direct quotes:

An indirect quote is the amount of foreign currency required to buy or sell one unit of the domestic currency. This is also known as a ‘quantity quotation’, since it expresses the quantity of foreign currency required to buy a unit of the domestic currency.

A direct quote expresses the price of one unit of a foreign currency in terms of the variable number of units of the domestic currency.

How to calculate exchange rates

To understand just how much money you can send to someone abroad or exchange for yourself, you’ll need to calculate how much the money you’re exchanging will buy you abroad. Just follow these steps:

For a truly accurate calculation, find out what the most up-to-date country exchange rate is for the country you’re sending or travelling to.

Divide your current (home) currency by the exchange rate.  For example, suppose that the USD/EUR exchange rate is 0.631 and you’d like to convert 100 USD into EUR. To do this, simply multiply the 100 by 0.631 and the result is the number of EUR that you’ll receive: 63.10 EUR. Converting EUR to USD involves reversing that process. Using the same example, if you took your 63.10 EUR and divided multiplied it by 0.631, you’ll end up with the 100 USD you started with.

If you don’t know the exchange rate, you can use the following simple currency conversion calculation to find it: take your starting amount (original currency) and divide it by ending amount (new currency) = exchange rate

For example, if you exchange 100 USD for 80 EUR, the exchange rate would be 1.25.

Cross Currency Rate Calculation

At one time, if you wanted to convert a currency you’d need to convert your domestic currency into US dollars before you could trade it for another. For example, if you’d wanted to convert your Swiss Francs into Japanese Yen, you would need to purchase US dollars to do so. This no longer applies. Cross currencies allow traders and individuals to convert currencies directly.

However, if you want to work out what the cross currency rate for the EUR/JPY is, then you need to look at both the EUR/USD and USD/JPY. These are called the legs of the EUR/JPY. This is the only way that you can see definitively how much the EUR/JPY cross currency pair should be trading for. The reason why this is a necessity is because they both use the US dollars as a common currency between them.

To calculate the bid price of the EUR/JPY pair, you must multiply the bids for the EUR/USD and the USD/JPY. That will give you the accurate bid price at any given time. It’s also possible to use the same calculation on the ask price to figure out what that should be for the cross currency pair.

For example: If the bid/ask for EUR/USD is 0.9800/0.9803 — and the bid/ask for USD/JPY is 144.71/144.78… How do you calculate the bid price for EUR/JPY? Simply multiply the bid for EUR/USD by the bid for USD/JPY, which yields 141.816.

When you know what the bid and ask price ought to be for the cross currency pair, then you are all set to make your determinations about how much you will receive when you convert your currency across pairs.

Tips on getting the best exchange rates

While you by no means need to be a foreign exchange specialist when changing money or sending money abroad, it is important to have a basic understanding on how to read and calculate exchange rates. Only that way will you be able to judge if you’re getting the best possible deal. 

I hope that this guide has given you some of the information you need. Here are some of the key take outs:

• Exchange rates never stand still – they are changing on a daily basis.
• The market rate is not the same rate as banks and providers offer. Banks calculate their exchange rates based on a number of factors, including: market conditions, competitive exchange rates, and their desired rate of return.
• In calculating exchange rates, find out what the most up-to-date country rate is for the country you’re sending or travelling to.
• Foreign exchange rates are available on a variety of websites – look at financial news publications, banks, foreign exchange providers and the google market exchange rate.
• When it comes to sending money to another country, it’s worth looking at several different  banks’ exchange rates as they may not compare that favourably to other specialist providers like WorldRemit. WorldRemit, as well as always trying to offer low fees, will try and offer better exchange rates which you can find via the WordRemit calculator.