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Every country has currency. The value of a county's currency (money, that unit of value for which goods and services are exchanged at a set rate, or price) is determined by complex factors some of which are inflation, interest rate, and world market demand for that currency. There is a world market demand for currency based largely upon import/export activity.
Because of world currency market demand for currencies of other countries--for example, the U.S. demands Japanese currency in order to purchase and import Japanese goods--agreements are made as to the worth or value of one currency in a foreign country. To put this in the plural, agreements are made between countries as to the worth or value of currencies in various foreign countries. These agreements are called "rates of exchange." These are the rates of value of currencies between foreign countries.
Some countries have "fixed rates of exchange," so their value per various foreign countries do not change until the government chooses to change the fixed rate. For example, China has a fixed rate of exchange based on the U.S. dollar. Since 1994, the China/ U.S. dollar rate has been fixed for the Chinese yuan at 8.28 yuan = USD1 (University of Florida EDIS, "Understanding Exchange Rates").
Other countries, like the United States and the United Kingdom (U.K.), have "floating exchange rates." In contrast to the Chinese fixed rate of exchange, which stays the same until the government changes it, a floating rate may change hourly or daily. The changes to a floating rate are highly sensitive to government fluctuations in a country's interest rate (e.g., if the Prime Interest rate is moved higher or lower), to fluctuations in the level of inflation and to changes in world currency market supply and demand.
To illustrate the above, import/export purchases or sales require a check on the current worth or value of the given currencies to learn the current rate of exchange of one currency for another because the prices and costs involved in the import/export transaction may be higher or lower than the last time a transaction was made between given countries. For example, The current rates of exchange between the U.K. Great Britain Pound and the U.S. United States Dollar, and in the reverse, is this (as of the timestamp of this answer):
- Pounds to Dollars GBP to USD 1.5707
Dollars to Pounds USD to GBP 0.6367
This means that at the moment, the Pound (GBP) is worth less than the Dollar (USD). Thus, for someone in the U.K. to buy goods from the U.S. will cost more per Pound than if they purchased the same thing in the U.K. To illustrate, to purchase a product in the U.K. costing 12.75 GBP will cost 20.0207 USD,using more money, if purchased from the U.S. This rate of exchange presents a small deterrent to importing U.S. goods into the U.K.
Since, for the moment, the USD is worth more than the GBP (GBP is worth less than the USD), the reverse of the above is true for the rate of exchange for USD to GBP. Thus, for someone in the U.S to buy goods from the U.K. will cost less per Dollar than if they purchase the same thing in the U.S. To illustrate, to purchase a product in the U.S. costing 12.75 USD will cost 8.1197 GBP, using less money, if purchased from the U.K. This favorable rate of exchange presents a mild encouragement to importing goods from the U.K. into the U.S. If the rates of exchange between the two were more steeply divergent, then the deterrent or encouragement would have a correspondingly greater effect.
Different countries around the world utilize different forms of currency for monetary transactions and trading. All of these different forms of currency have different inherent values in relation to each other. The values of the currencies in relation to each other at a given point in time is called the spot exchange rate. Currency values are always fluctuating, so the spot exchange rate between two currencies will be constantly changing, even by the hour.
Let's take the US dollar and the EU euro as an example. As of the time stamp of this answer, the exchange rate of between the dollar and the euro is 0.7493. In other words, for every one dollar that you want to convert to a euro, you will get 0.7493 euros in exchange. If you were going in the other direction, then one euro would exchange into 1.3347 dollars. From these numbers we can tell that the euro currently trades at a higher value than the dollar (one euro is worth more than one dollar). Keep in mind that when you actually exchange foreign currencies at a bank or financial institution, you will always pay a little more than the true spot exchange rate in order to accomodate a profit margin for the bank facilitating the transaction.
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