exchange rates – the value of one currency for the purpose of conversion to another
To remember what exchange rates means use the following mnemonic:
I want to exchange this money, but at this rate (exchange rate), it'll be worth nothing. The value of this currency for conversion into another currency is falling fast.
An exchange rate is just a price of one country’s currency in terms of another country’s currency. Here below is an example of how exchange rates are displayed:
GBP (UK)/USD (USA) 1.35
The first currency listed (here the British Pound) always stands for one unit of that currency i.e., £1 buys $1.35
So, if you have £1000, use the following formula:
Money you have x Exchange rate = Money after exchange
£1000 x 1.35 = $1350
1000 pounds would buy 1350 dollars
What happens if the pound gets stronger?
If the exchange rate is GBP/USD 1.35, but the pound then becomes stronger, it may change to GBP/USD 1.45
This means the pound has risen compared to another currency and you would get more of the other currency for it. A British business would not have to spend as much money when buying the same piece of equipment from America for example.
For exchange rates think:
SPICED is the acronym to remember what happens when the GBP exchange rate strengthens.
When it weakens, think of the reverse.
A weakening of the pound means for most citizens goods and services imported into the UK will rise:
E.g., oil imported will rise in price
However, for businesses in the UK that export to other countries, the fall in the value of the pound makes their products more price competitive to foreign buyers.
Why are there buy and sell rates?
In order to make profits, banks and other currency traders use different rates than the rates you’ll see on the internet. The online rates you see are likely interbank rates.
The average person or small business would not get these rates when trading currency.
For example, the internet trading rate may be GBP/USD 1.35. 1 pound buys 1.35 US dollars (between banks), but if the average person is looking to trade money, you will see:
WE BUY: GBP/USD 1.32
1 pound buys 1.32 US dollars
And if you had dollars to be converted back to pounds:
WE SELL GBP/USD 1.36
1.36 US dollars gives you only 1 pound
Exchange rates can fluctuate significantly which can have a big impact on businesses that operate internationally. However, all businesses are affected in some way. It is rare for a product not to contain at least some materials or parts produced in other countries and therefore these elements will alter in price.