Here we take a closer look at the structure of exchange rates
The exchange rate of a currency (the designation of a currency accepted abroad) is the rate, that is, the price, of this currency in relation to another currency.
On financial reporting websites or specialized pages of newspapers, we can read, for example, EUR / GBP=0.8250/0.8252. The first price is the selling price of the first currency mentioned, here the euro. The second price is the buying rate of the first currency.
In explicit terms, EUR / GBP=0.8250/0.8252 means that one euro (EUR) is sold at a price of 0.8250 pounds sterling (GBP) and one euro is bought at a price of 0.8252 pounds sterling. The convention requires these exchange rates to be expressed in four decimal places.
It is easy to distinguish the selling price from the buying price, remembering that the selling price is always lower than the buying price. Depending on the commission charged by the stock broker, the gap between the ask price and the buy price, also called the spread, can be larger or smaller.
For simplicity, and in order to establish an international standard for speaking about all currencies anywhere in the world without language barriers, each currency has a three-letter abbreviation. Often, but far from being a general rule, the first two letters indicate the country, and the third refers to the name of the currency. For example, here are the abbreviations for the US, UK, Chinese and Japanese currencies:
USD for the US, D for the dollar per pound for the UK, P for the pound (pound in French) CNY CN for China, Y for the yuan JPY JP for Japan, Y for the yen.
Namely, the euro is a notable exception as it has the abbreviation EUR.
Finally, it is impossible to estimate the value of a currency in absolute terms. That is why it is always expressed relative to another currency by an exchange rate and by observing changes in that rate over time. Thus, each currency has an exchange rate with respect to each of the other currencies. A bilateral exchange rate is referred to as a bilateral exchange rate to refer to the ratio between two currencies and the actual exchange rate when considering all bilateral exchange rates. To establish it, usually each bilateral exchange rate is weighted by the share of the country's international trade in that currency.
Why are exchange rates important?
Exchange rates are of great importance for a country's economy, and especially for its foreign trade.
For example, suppose that the euro appreciates against the dollar, that is, the exchange rate of the euro against the dollar rises and after a few months has risen from 1 euro = 1.35 dollars to 1 euro = 1.50 dollars.
As for goods and services, then the products exported by the United States to the eurozone countries will be more competitive. Example: 1 DVD "made in USA" worth 20 dollars cost 14.8 euros (or 20 dollars / 1.35 dollars) in the eurozone. In a few months it will cost 13.3 euros (or 20 dollars / 1.50 dollars). Conversely, goods exported from the Eurozone will have a higher price in US dollars and will be less competitive in the US compared to local products.
But if there is not enough domestic production to avoid an increase in imports - which can be the case for energy or raw materials, often coming from emerging markets - this can be a factor in inflation in a country with a depreciating exchange rate, in this case the United States. in our example.
Finally, at the individual level, as the euro/dollar rises, American tourists will lose their purchasing power in the eurozone, and conversely, French or German tourists will find it cheaper to stay in the United States. In terms of investment and investment, European assets are worth more to US investors, while US assets are worth less to investors in the Eurozone: so a depreciation of the dollar is logically beneficial for investing in the US.
Exchange rates are set in the foreign exchange market. Each country or currency area determines its own currency regime, fixed or floating.
Exchange rate policy.