What is the meaning of the currency

Exchange rate - what is the exchange rate?

The exchange rate is the price of one currency in another currency. The currency is the legal tender of a country. In Germany, for example, it is the euro and in the USA it is the dollar. The price of a currency is formed on the global foreign exchange market.

With the accounting program Debitoor you can create invoices in different currencies.

The exchange rate always represents the value of two currencies. The price is determined, among other things, by supply and demand on the foreign exchange market. Exchange rates lead the exchange ratio between the currencies.

An example: Sabine from Hamburg would like to spend a weekend in London. Currently, the British pound to euro exchange rate is 1.19. So that means that she can exchange 1.19 euros for 1 pound. So if Sabine wants to change € 50 at a bank, she gets £ 59.50 for it (plus any fees that she has to pay at the bank).

What is the significance of the exchange rate?

The exchange rate is one of the most important economic factors in the world. It is of decisive importance with regard to the international competitiveness of a state and has a decisive influence on it from an economic point of view.

Example: Let's say a dollar costs one euro. The euro will appreciate by 20 percent, which means that one euro now costs 1.20 dollars. An importer from the USA now has to pay $ 20 more for goods worth € 100. Accordingly, the export from the country with the revalued currency will be more expensive.

In addition, imports from the euro zone will be cheaper for the importer. If goods from the USA cost $ 100, the importer only pays $ 83.33 after the euro has appreciated.

Commodities are generally traded in dollars, which is why they are now also cheaper. This manifests itself, for example, in the fall in gasoline prices.

Changes in the exchange rate pose a particular risk for entrepreneurs and investors - the so-called exchange rate uncertainty - if claims are linked to a foreign currency.

How are exchange rates formed?

On the one hand, exchange rates can be freely formed on the market. On the other hand, the rate can be determined by a central bank. It used to be common to link the exchange rate or conversion rate to a key currency.

This was the case, for example, after the Second World War. The US dollar was the key currency here. This system is also known as the Bretton Woods system. Even today there are countries that peg the rate of their currency to the US dollar, the euro or another currency. China, for example, is pegging its currency, the yuan, to the dollar.

Distinguishing criteria for exchange rates

Exchange rates therefore differ from one another in the way in which they are determined. If you include the price level in the calculation, you separate the nominal and real exchange rates from each other.

According to the number of countries against which the exchange rate is calculated, bilateral and effective (multilateral) exchange rates are differentiated from one another.

Nominal and real exchange rates

The nominal exchange rate indicates the ratio in which a country's currency can be exchanged for another country's currency. For example, when it comes to the dollar and the euro, on December 11, 2019 (at 11:27 a.m.) you get 0.90 euros for one dollar.

The euro rate and all other rates of the respective currency change constantly. The fact that exchange rates are subject to regular fluctuations is known as exchange rate volatility.

The real exchange rate is the ratio between the representative basket of goods of two countries that can be exchanged. It forms the value ratio of two currencies.

In other words: the real exchange rate represents the purchasing power of a state. Here the income or the representative basket of goods of two countries is compared.

An example to clarify: Anna lives in Zurich. Hans lives in Berlin. If you compare the incomes of Hans and Anna and "only" convert the currency, it is a one-sided view. What is decisive for the person is what they can buy for their money in their home country.

If Hans from Berlin earns 2,000 euros and a bread costs 2 euros, for example, he could buy 1,000 loaves of bread for his earnings. Anna from Zurich, on the other hand, earns 3,200 Swiss francs and pays 4 francs for a bread. She can only buy 800 loaves a month for her salary, although she earns the equivalent of more.

Bilateral and multilateral exchange rates

The bilateral exchange rate is used when the exchange rate refers to two currencies.

An effective, or multilateral, exchange rate describes the exchange rate between a currency and a currency basket. A currency basket combines different currencies into one unit.

The importance of the exchange rate for our economy

The most important indicator of the competitiveness and performance of a country's economy is the effective exchange rate. If the exchange rate changes, this has an impact on macroeconomic development in countries that are export-oriented. This also includes the Federal Republic of Germany.

If a currency is devalued, it means that domestic goods become cheaper for customers abroad. In this way, the domestic economy can benefit from increasing exports.

However, if the currency appreciates, this has exactly the opposite effect. Imports are cheaper and exports are correspondingly more expensive.

How is the exchange rate calculated?

The exchange rate is different for each country and can be calculated with a converter. You can find numerous currency converters with your favorite search engine on the Internet and get the current exchange rate.

Write invoices in other currencies

Do you work internationally with your company and send invoices to countries that use a different currency? It is important to convert the currency correctly.

The easiest way to do this is with billing software. Here you can change the currency on the invoice as you like and the exchange rate is automatically adjusted on a daily basis. You can find out more about invoicing in different currencies on our blog.