Exchange Rate

Written by True Tamplin, BSc, CEPF® | Reviewed by Editorial Team

Updated on December 22, 2022

Define Exchange Rate in Simple Terms

An exchange rate is a metric by which the value of one currency is compared to another. It can be thought of as a measure of how much of the second currency can be "bought" with an amount of the first currency.

What Does Exchange Rate Mean in Finance?

The purpose of an exchange rate is to figure out the buying power of a currency as compared to another currency.

Not all currencies have the same buying power per unit, so knowing the exchange rate helps determine the "value" of an amount of money. For example, the exchange rate of US dollars (USD) to Pound sterling (GBP) is 1.24. 

This means that it takes $1.24 to equal  £1. Put another way, if a US citizen traveled to the UK with $10,000 to exchange into pounds, they would get about  £8,034.

Exchange Rate Example

Several factors influence exchange rates. Most exchange rates are free-floating, meaning they rise and fall in accordance with fluctuations in supply and demand in the foreign exchange market.

Other currencies may be pegged, meaning that their value is tied to the value of another currency within a certain margin; the Hong Kong dollar, for example, is pegged to the US dollar at a range of 7.75 to 7.85, so its value will stay within this range of the USD.

Some currencies have different exchange rates depending on whether or not the funds are held inside or outside a country's borders. The Chinese Yuan (CNY), for instance, has an exchange rate of  ¥7.05 per $1 outside its borders, but  ¥7.04 per $1 inside.

Exchange Rate FAQs

What is an Exchange Rate?

An exchange rate is a metric by which the value of one currency is compared to another.

What is the purpose of an Exchange Rate?

The purpose of an exchange rate is to figure out the buying power of a currency as compared to another currency.

Why would I want to know a currency's Exchange Rate?

Not all currencies have the same buying power per unit, so knowing the exchange rate helps determine the “value” of an amount of money.

Why do some currencies have different Exchange Rates?

Some currencies have different exchange rates depending on whether or not the funds are held inside or outside a country’s borders.

What's an example of a currency exchange?

For example, the exchange rate of US dollars (USD) to Pound sterling (GBP) is 1.24. This means that it takes $1.24 to equal £1. Put another way, if a US citizen traveled to the UK with $10,000 to exchange into pounds, they would get about £8,034.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

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