Exchange rate
What is Exchange rate?
An exchange rate is the price of one currency expressed in units of another currency.
Every displayed rate needs an explicit numerator and denominator. A chart labeled currency strength without quote direction invites sign errors. Performance systems should store the native observation and derive inverses mathematically, avoiding separately sourced reciprocal series that differ because of timestamps, rounding, bid-ask sides, or vendor conventions.
Return calculations should use multiplicative compounding rather than simply adding local and currency percentage changes.
Triangulated cross rates should use internally consistent bid and ask sides and a common timestamp.
Quote convention
A pair such as EUR/USD states dollars per euro under the conventional order. If EUR/USD rises, the euro appreciates against the dollar and the dollar depreciates against the euro. Inverting the pair reverses direction. Market conventions vary by currency and instrument, so labels must state which currency is base and which is quote.
Bid, ask, and midpoint
Dealers quote a bid at which they buy the base currency and an ask at which they sell it. The spread and market impact are transaction costs. Midpoints and benchmark fixings support valuation but may not be executable. Rate, side, size, timestamp, value date, and venue are all part of a meaningful quote.
What moves rates
Relative inflation, interest rates, growth, trade, capital flows, fiscal and monetary policy, political risk, valuation, positioning, and risk appetite can affect currencies. Market prices reflect expectations, so apparently good economic news can weaken a currency if it was anticipated or changes expected policy differently than the headline suggests.
Return translation
For an unhedged foreign asset, base-currency growth equals the local asset growth multiplied by the currency growth, then minus one. A 10% local gain and 5% currency gain produce 15.5%, not 15%. Distributions and cash flows require rates from their own dates rather than one period-end conversion.
Practical use
Specify pair, direction, source, timestamp, side, and value date. Align market calendars and avoid mixing fixing, close, midpoint, and execution. For historical comparison, preserve point-in-time rates and redenominations. Do not infer purchasing power, investment value, or economic strength from one nominal bilateral rate without inflation and broader context.
Sources and further reading
- Triennial Central Bank Survey of foreign exchange and Over-the-counter Derivatives Markets, Bank for International Settlements
- Currency Exchange Rates: Understanding Equilibrium Value, CFA Institute