Currency exchange rates: What they are and how they work

Currency exchange is swapping currency from one country for currency from another. An exchange rate is the value of one currency against the value of another, based on supply and demand, among other factors.

How does currency exchange work? This is one of many questions a traveler may have when preparing for a big international trip.

With more than 90% of North American manufacturing companies doing business outside of North America, both individuals and businesses can benefit from understanding different international payment types and how currency exchange works.¹ This is important for managing costs, mitigating risks, and enabling further expansion.

Continue reading to learn more about currency exchange, how to calculate it, and why it matters.

What is a currency exchange?

Currency exchange is essentially swapping one country's currency for another. Its value (exchange rate) changes based on various factors, such as economic conditions and supply and demand.

For example, a United States resident attending a conference in Italy can't exactly use U.S. dollars to buy gelato in Rome or cruise the Venice Canal on their free day. So, they’ll need to exchange their U.S. dollars for euro to complete the cross-border payout cross-border payout.

Currency exchange comes into play in many ways, from buying and selling goods to traveling the world. If a Canadian company wants to buy electronics from South Korea, it must pay in South Korean won. If someone from the U.K. invests in a company in the U.S., they'll likely need to convert their British pounds into U.S. dollars, and so on.

So, whether it's for trading goods or paying overseas contractors, currency exchange is the behind-the-scenes process that makes all that possible.

How does a currency exchange work?

Users buy and sell currency on the global foreign exchange (FX) market, where their values (exchange rates) constantly change based on supply and demand. Think of it as a giant marketplace for swapping currencies.

High demand makes a currency more valuable, while high supply makes it less so. The market allows businesses and individuals to exchange currencies, which is important for cross-border transactions.

Currency convertibility refers to how easy it is to exchange a country's money for other currencies.

• Fully convertible currencies are freely traded, indicating a stable economy.
• Partially convertible currencies have some exchange restrictions, while nonconvertible currencies are mainly for domestic use.

What is an exchange rate?

An exchange rate compares the value of one currency to another. If an American entrepreneur is on their way to Italy to source materials, the amount of EUR they get for their dollar is its exchange rate, which changes often, depending on what's going on in the world.

A currency pair, such as the USD and the EUR, represents the exchange rate between two different currencies. It shows how much of one currency (the quote currency) is needed to purchase one unit of the other currency (the base currency). Currency pairs are the fundamental units of trading in the foreign exchange (forex) market. So, as of April 2025:

1 United States dollar (USD)=0.88 euro (EUR)

If we use the U.S. dollar as the base rate and the euro as the exchange rate, that makes the USD/EUR exchange rate 0.88. So, for every U.S. dollar a person has, they would receive eighty-eight euro cents in exchange at that particular rate.

Floating vs. fixed exchange rates

Floating exchange rates fluctuate based on supply and demand in the forex market, with minimal government intervention. The currency's value adjusts to economic shifts. Many major global currencies, like the US dollar, euro, and Japanese yen, operate under a floating exchange rate.

Fixed exchange rates are an international pricing model that governments set and central banks maintain. They're often pegged to another currency or commodity. This exchange rate system provides stability but requires reserves and limits monetary policy flexibility.²

Floating:

• Based on supply and demand
• Minimal government intervention
• Adjusts based on the economy
• Most major global currencies use a floating rate

Fixed:

• Government sets value
• Maintained through the central bank
• Often tied to another currency or commodity
• Provides greater stability, but limits flexibility

Why do exchange rates fluctuate?

Exchange rates fluctuate due to shifting supply and demand for currencies. Economic factors, like interest rates and inflation, political stability, and market sentiment, drive this demand.

In countries with stable governments and thriving economies, currencies tend to be stronger. Traders speculating on future currency movements also contribute to these constant changes. Ultimately, the balance between how much of a currency is bought versus sold determines its value against another.

How is an exchange rate calculated?

Exchange rates are determined by the fluctuating supply and demand for currencies in the global market, influenced by economic, political, and market factors.

Exchange rate quotations show a currency's value against another. A direct quote (from a U.S. perspective) is USD/[foreign currency] (e.g., USD/CAD = 0.74 means 1 USD buys 0.74 CAD).

An indirect quote is [foreign currency]/USD (e.g., CAD/USD = 1.35 means it costs 1.35 CAD to buy 1 USD).

Some currencies' value also changes based on direct intervention. Fixed exchange rates are government-controlled, while floating rates are market-driven.

Example:

• A Swiss watch costs 200 euro (EUR)
• Exchange rate is USD/EUR = 1.10 (1 USD buys 1.10 EUR)
• 200 EUR / 1.10 USD/EUR ≈ $181.82 USD
• Cost in U.S. dollars (USD) is $181.82 USD

Exchange rate examples

Currency pairs are typically quoted with the first currency being the base currency (the one that's bought or sold) and the second being the quote currency (the price). The exchange rate tells you how many units of the quote currency have the same value as one unit of the base currency.

Here are a few examples of how currency exchange rates work to illustrate how to express the value of one currency in terms of another. These rates are constantly fluctuating in the real world due to various economic factors.

Example 1

USD/CAD = 1.37: This quotation means that 1 U.S. dollar is as valuable as 1.37 Canadian dollars. This would be an indirect quote from a Canadian perspective, indicating that one Canadian dollar buys approximately 0.73 US dollars.

Example 2

EUR/USD = 1.08: This shows that 1 euro is as valuable as 1.08 US dollars. This is a direct quote for someone in the Eurozone, meaning one euro costs 1.08 US dollars.

Example 3

GBP/JPY = 165.20: This indicates that 1 British pound is as valuable as for 165.20 Japanese yen.

Where can I find currency exchanges?

There are several currency exchange options, each with advantages and disadvantages.

• Banks: The traditional choice, banks typically offer high security and familiarity. However, they often have less competitive exchange rates and can charge significant transaction fees.
• Online platforms: Having gained popularity for their convenience, these platforms make it easy to send and accept foreign transactions. They allow you to exchange currency from anywhere with an internet connection and frequently offer better exchange rates than traditional banks due to lower overhead.
• Currency exchange bureaus: Easily accessible, especially in tourist areas, currency exchange bureaus’ exchange rates can vary widely and may include high commissions or less favorable spreads.
• Credit cards: For international purchases, credit cards can be convenient, but they are typically subject to the card issuer's exchange rate, which may include a cross-border fee (usually a percentage of the purchase).

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If manufacturing, cross-border e-commerce, or other aspects of a business take place outside the country, it's important to know how currency exchange works.

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