Foreign Exchange Rate

By: EconomyWatch   Date: 23 November 2010

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A foreign exchange rate, which is also called a forex rate or currency rate, represents the value of a specific currency compared to that of another country. Currency rates are applicable only on currency pairs. The currency listed on the left is called the reference (or base) currency while the one listed to the right is the quote (or term) currency.

Exchange rates are always written in the form of quotations. A quotation reflects the number of quote currencies that can be bought by using a single unit of reference currency.

Exchange Rate: Determining Base and Term Currencies

When an exchange rate is quoted for a currency pair, the currencies are usually quoted in order of their importance, which is as follows:

  • Euro (EUR)
  • Great Britain pound (GBP)
  • Australian dollar (A$)

  • United States dollar (US$)

  • Other currencies

 

In case the conversion is from a Great Britain pound to an Australian dollar, the Great Britain pound would be placed on the left. It will be the base currency.

In certain markets in the United Kingdom and Europe, the order is determined differently. The position of the Great Britain pound and Euro is switched. The pound is treated as the base currency and the Euro is considered as the term currency.

If the currency pair does not comprise any of the currencies listed above, the Forex market considers that currency as the base, whose exchange rate is more than 1.000.

In other countries like Japan, they use the home currency as the base. This method of quoting exchange rates is called direct quotation or price quotation.

Types of Exchange Rate

Spot exchange rate: This is the exchange rate that is currently applicable.

Term forward rate: This is an exchange rate that is currently quoted and used for trading.

Determining Currency Exchange Rates

Fixed rate: This currency exchange rate is determined by a government agency or the central bank. This official exchange rate is regularly monitored by the bank and maintained by using the country’s own foreign exchange reserves.

Floating rate: In this flexible exchange rate regime, the private market determines a currency’s value. However, the value fluctuates according to the demand/supply trends in the foreign exchange rate market.


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