Learning how to calculate exchange rate is essential if you want to make your money go further in a foreign currency. It will help you work out whether the exchange rate you’re being offered by a currency dealer is the best one available.
Knowing how much foreign currency you can get for your hard-earned cash will also allow you to budget for foreign holidays and make savvy investment decisions.
So, let’s dive into the ever-changing world of currency conversion and discover how to work out exchange rates.
What is a Foreign Exchange Rate?
The idea of putting a price on money itself is quite strange when you think about it, but that’s what currency traders do. One currency’s value can only be defined in relation to another currency, so that’s why you always see exchange rates in pairs.
The first (base) currency is always expressed as 1 unit. Therefore, 1 euro costs 1.25 dollars here. If you have only euros and you want to get hold of dollars, you’re going to have to part with 1 euro to get 1.25 dollars in exchange.
Exchange rates are constantly changing because one currency’s value in relation to another is different day-to-day (or even second by second!). Say the US economy shrinks while the Eurozone economy grows: our example above might change to EUR/USD 1.30. Your 1 euro suddenly goes further, in terms of the number of dollars you can buy.
Where Can You Find Current Exchange Rates?
It’s easy to find the current market exchange rate for different currencies online, on currency trading or bank websites. However, if you go into your local post office, a bank branch, or an airport currency kiosk, you might see different rates to those you’ve found online.
In order to make money, a currency exchange service will offer an exchange rate that is less favourable than the market rate. So if our example of EUR/USD 1.25 is the market exchange rate, the airport kiosk might display EUR/USD 1.22. So you’ll get fewer dollars for your euros and the dealer keeps the difference.
If you can work out the exchange rate yourself, you’ll be able to determine which currency exchange service offers the best deal.
What is the Formula for Calculating Exchange Rates?
Although you can find exchange rate calculators online, it’s useful to know how to convert currency manually. And currency conversion maths isn’t difficult – you just need a bit of practice.
Let’s say you have £1,000 set aside as spending money for your holiday in California. You look online and you see that the current exchange rate is GBP/USD 1.25. As the base currency in that exchange rate is the same as the currency you want to convert (GBP), you need to multiply £1,000 by $1.25 per £1.
Result: Your £1,000 will get you $1,250 for your holiday.
But what if the exchange rate is swapped around? It now looks like this: USD/GBP 0.80
The base currency has changed to USD, so the exchange rate is now telling us that 1 dollar can buy you £0.80. However, we can still use this new exchange rate to convert GBP into USD. We just need to reverse the formula and divide our £1,000 by £0.80 per $1. The result is the same as above: $1,250.
To Summarise the Exchange Rate Formula...
A simple way of thinking about calculating the exchange rate is (e.g. from £ to $):
C = A x B:
- A = Money you have
- B = Exchange rate
- C = Money after exchange
A is £1000, B is 1.25
£1,000 x 1.25 = $1,250
Comparing Currency Exchange Deals
Let’s take another example. You want to convert your £1,000 holiday spending money into dollars and you have the option of:
- Exchanging it at a bank for GBP/USD 1.22
- Exchanging it at an airport kiosk for USD/GBP 0.84
Which deal should you go for?
With the bank’s offer you should multiply your £1,000 by $1.22 per £1. This deal will give you $1,220 for your £1,000.
With the airport kiosk’s offer you should divide your £1,000 by £0.84 per $1. This deal will give you $1,190 for your £1,000.
So the bank’s deal is the one to go for if you want to have more dollars to spend on holiday!
How to Convert Currency: Key Takeaways
Learning the simple exchange rate maths above can help you get the most out of your money. Whether you’re going on holiday, getting paid in a foreign currency, or sending money abroad, you want to know that you’re getting a fair price for your pounds.
Want to know more about international payments? Check out our related blog post:
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