Understanding currency exchange rates might not sound like the most fun topic to study. However, if you are looking to send money overseas, knowing about it could wind up saving you money.
It determines how much money you can get while converting one currency to another. The best exchange rates will give you more foreign currency for your dollars.
In this article, you’ll learn everything you need to know about exchange rates and why it is important when sending money overseas.
When people talk about "the exchange rate" between any two currencies, they are referring to the mid-market exchange rate. In other words, an exchange rate is the relative price of one currency expressed in terms of a foreign currency value (or group of currencies). For example, 1 USD equals 82.27 INR.
It is called the mid-market rate because it is the midpoint between the buying and selling prices of any two currencies at any time.
Also known as interbank rates or the intermediate rate, this is the rate at which banks trade currencies with one another.
Foreign exchange markets are the global marketplace in which national currencies are traded for foreign currency transactions.
Price differences between purchases and sales are called Spreads. The average of this spread (buying and selling prices) determines the mid-market rate.
Each currency pair has its specific mid-market rate which is influenced by imports, exports, trade balances, political situations, economic growth, etc. That is why the buy and sell rates of the currency tend to change according to the supply and demand of the currency in the foreign exchange market.
Furthermore, the foreign exchange rate of a country act as a window to the health of its economy.
There are many free online tools that you can use to find mid-market rates. Here are a few of them that you can use as an exchange rate calculator as well:
There are different types of exchange rate regimes that a country might choose to operate under. You may have seen exchange rate descriptions that are floating or fixed.
Here, the exchange rates are generally determined by the market forces of supply and demand in foreign exchange markets and hence fluctuate constantly.
World's major currencies such as the US dollar, the Euro, the Japanese yen, and the UK pound sterling use the floating exchange rate.
A fixed or pegged exchange rate is linked to the value of another currency (usually the U.S. dollar, but may also include other major currencies like the euro, the yen, or a basket of currencies). For example, the Hong Kong dollar is pegged to the U.S. dollar in a range of 7.75 to 7.85. So, the value of the Hong Kong dollar relative to the U.S. dollar will remain within this range.
Under the pegged regime, the central bank or monetary authority maintains the rate by buying and selling its currency on the foreign exchange market in return for the currency to which it is pegged.
Fixed exchange rates work well for growing economies that do not have a stable monetary policy. It helps bring stability to a country's economy and attract foreign investment. Floating exchange rates work better for countries that already have a stable and effective monetary policy.
As we have discussed, the rates are determined by the economies' activity, interest rates, GDP, or even unemployment rates of all the countries. Here we explain the major factors contributing to the fluctuating exchange rates.
Inflation is defined as a currency's relative buying power compared to other currencies.
Low-inflation countries tend to have stronger currencies than those with higher inflation rates. Higher inflation rates, on the other hand, cause the currency to depreciate, losing purchasing power and value in comparison to other currencies.
Inflation, interest rates, and exchange rates are all linked together. Each of these variables has the potential to influence the other two. Low inflation and high-interest rates increase the demand for the currency.
However, if these rates are too high for too long, inflation will begin to rise, resulting in currency depreciation.
The majority of countries use large-scale deficit financing to fund their budgets. If government debt grows faster than the economy, it can raise inflation by preventing foreign investment from entering the country, both of which can depreciate a currency.
The value of a currency's exchange rate will fall if foreign investors lose their confidence in the government.
The balance of trade also referred to as the terms of trade, is the relative difference between an economy's imports and exports. For instance, a positive trade balance indicates that a country's exports are greater than its imports. In this case, the inflow of foreign currency exceeds the outflow. A country's foreign exchange reserves rise as a result, enabling it to lower interest rates and promoting economic growth and the local currency exchange rate.
The current account deficit and the balance of trade are inextricably linked. A current account deficit occurs when a country spends more than it earns.
In this case, a country's trade balance is contrasted with that of its trading partners. When a country's current account deficit is greater than that of a trading partner, it may cause its currency to depreciate relative to that trading partner's. Because of this, currencies in countries with positive or low current account deficits are frequently stronger than those in those with large deficits.
A country with a stable political environment attracts more foreign investment, which helps to keep the currency rate constant. Poor political stability, on the other hand, devalues a country's currency exchange rate.
To regulate exchange rates, a country's central bank can adjust interest rates, buy foreign currency, influence local lending rates, print money, and utilize other measures to create favorable conditions for a stable currency exchange rate.
Despite the fact that the exchange rate is not a fee, it is a cost of money transfer that must be considered. It will determine how much money will be received on the other end, or how much money must be given to ensure that the recipient receives the needed amount.
In addition to transfer fees, money transfer companies and banks often add a margin to the mid-market to make a profit.
While banks and money transfer services use the mid-market rate for trading currencies between themselves, they set different exchange rates for customers.
The exchange rate margin is the percentage difference between the mid-market rate and the rate offered to customers. This difference in rate is one of the ways banks and providers make money. Even a slight difference in the rate can make a huge difference when sending a large amount of money.
Some specialized money transfer companies, such as Wise and Instarem, offer a mid-market rate to send money overseas. Some may even allow you to lock in a favorable rate for a set period of time, ensuring that rate fluctuations do not affect your transfer.
However, in general, most banks and money transfer providers add the exchange rate margins. This can increase the cost of your transfers.
If you want to save money on international money transfers, you should transfer money as closely as possible to the mid-market exchange rates. Mid-market rates are considered the fairest rate possible.
This rate is a good starting point to compare with what transfer companies offer to see if it is a fair exchange rate. To do this, you can use a search engine to find the current mid-market rate of your selected currency pair before proceeding with the transaction. Most transfer providers will show you the rate for your transfer before you press send.
When using international wire transfers via banks, you can find that FX rates are not nearly as favorable as inter-bank rates. Banks often add a markup to the interbank rate. The costs of currency conversion are sometimes not disclosed to the customer. And they wind up paying exorbitant fees without even realizing it as hidden fees.
Furthermore, compared to bank fees, third-party money transfer services' transfer fees and exchange rate margins are substantially lower.
To check the current exchange rates when sending money overseas, use our online comparison tool to view offers from top providers today!
Download Our Free App
Try our faster, enhanced mobile app for a better experience