What is an Exchange Rate?

An exchange rate between two countries' currencies indicates the value of one currency relative to the other.

Exchange Rate Example

Let's say the current exchange rate between the dollar and the euro is 1.23 $/€. This means that to obtain one euro, you would need 1.23 dollars. Conversely, if you were about to take a vacation to Europe, you could take $1,000 to the bank and receive €813.01.

Exchange rates can be fixed or floating. If a country fixes its currency to that of another country, the exchange rate between those two currencies will not change. If a country has a floating exchange rate, however, the rate between its currency and any other currency will adjust to market conditions.

Why the Exchange Rate Matters

The exchange rate between two currencies plays a major role in international trade and investment. For instance, if the dollar appreciates, or gains value, relative to the euro, Americans traveling in Europe will have greater purchasing power, but it will be more difficult for U.S. businesses to export goods.

Fluctuations in the exchange rate are subject to a wide range of factors, such as interest rates, price levels, geo-political safety concerns, and expected future market conditions.

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.