What is an Exchange Rate?
An exchange rate is the price at which one currency can be exchanged for another. The currencies involved are most commonly national, but may also be sub-national, such as in Hong Kong, or supra-national, such as the euro. The exchange rate will be determined by the demand for the currency and its supply. In a free market, the exchange rate will fluctuate as demand varies across countries.
There are two types of exchange rates: the official rate and the market rate. The official rate is the one established by the government, while the market rate is determined by legal market forces. The former is the official rate, while the latter is known as the secondary or tertiary rate. In the United States, the official rate of the dollar is usually different from the market rate.
Currency exchange rates change over time. For example, the exchange rate of a Canadian dollar against the US dollar in late August 2020 is 1.31. This means that for every one US dollar that is exchanged, you’ll receive $1.31. The other way is to calculate a foreign currency exchange rate for a particular country’s currency.
Another type of currency exchange rate is the interest rate. Inflation is closely related to the exchange rate. When interest rates rise, investors demand more currency. This will affect the value of domestic currency and demand from overseas customers. Interest rates are based on market demand and economic activity. When the economy of a country is unstable, foreign capital tends to invest in safe-haven currencies. In the United States, the dollar is the global federal reserve currency, which drives the baseline demand for this currency.