Exchange rates – what they are

Exchange is an operation of exchanging one currency for another (for example, exchange of dollars for euros).

The exchange rate is the price at which this exchange is made, i.e. the value of one currency in currency units of another currency.

The exchange rate reflects the relative price of currencies, indicating the amount of currency that can be bought (or sold) through the sale (or purchase) of a unit of another currency (base currency).

The exchange rate is usually represented by the symbol of the base currency followed by the symbol of the second currency:

  • EUR/USD represents the price, in US dollars, of each euro;

  • USD/JPY represents the price, in Japanese yen, of each US dollar.

A EUR/USD exchange rate of 1.5415 means that in order to get 1 euro it is necessary to deliver USD 1.5415, i.e. each euro is worth USD 1.5415.

  • An increase in this price reflects an appreciation of the euro against the dollar and means that for each euro it is necessary to deliver more dollars;

  • A reduction in the value of that exchange rate indicates an appreciation of the dollar against the euro.

 

Note: By convention, the USD is quoted against the EUR up to the fourth decimal place (while the JPY exchange rate against the USD is approximated to the second decimal place, for example).

‘Direct and ‘indirect’ quotations

The exchange rate can be considered:

  • ‘direct’ – this refers to the number of foreign currency units required to acquire a unit of national currency;

  • ‘indirect’ – this is the number of national currency units required to acquire a unit of foreign currency.

In general, exchange rates are published as ‘direct’ quotations, indicating how much a national currency unit is worth in foreign currency.

 

Inverse quotations

The inverse quotation of the EUR/USD, i.e. the USD/EUR, represents the price in euros of each dollar. For example, the EUR/USD exchange rate of 1.5415 means that the inverse quotation, USD/EUR, corresponds to 0.6487, i.e. the inverse of 1.5415 (1/1.5415).

If USD/EUR = 0.6487, each dollar is worth less than one euro, which means that the euro is worth more than the dollar. In this case, it means that in order to obtain one US dollar, it is necessary to deliver 0.6487 euros.

 

Cross quotations

A currency may not have direct quotation in all foreign currencies. The calculation of the cross quotation makes it possible to obtain the exchange rate of a currency for which there are no published quotations.

Where two different exchange rates are available with a common currency, it is possible to calculate the cross exchange rate.

If, for example, the EUR/USD and USD/JPY values are available, the value of the EUR/JPY can be calculated as follows:

EUR/USD = 1.5326 means that 1 EUR = 1.5326 USD

USD/JPY = 105.33 means that 1 USD = 105.33 JPY

Hence, EUR 1 = 1.5326 x (JPY 105.33) i.e. 1 EUR = JPY 161.43. Hence, we get the quotation EUR/JPY = 161.43.