The exchange rate is defined as the price of a monetary unit of a country, expressed in terms of a different currency. We can also say that the exchange rate is the equivalence relationship that exists between two different currencies.
Exchange rates vary constantly, they are determined by the supply and demand of each currency in the foreign exchange market or FOREX.
It is said that the exchange rate is fixed when it is established by the Central Bank and that the exchange rate is floating when it is established according to supply and demand.
Exchange rates are expressed as follows. If we want to see the relationship or exchange rate that exists between the euro and the dollar, we will express it as follows
EUR/USD = 1.23
This means that for each euro we get 1.23 dollars. In this case the is the base currency and the $ is the quote currency.
We can get the exchange rate in reverse:
USD/EUR= 1/1.23 = 0.81
This means that one dollar is worth 0.81 euros. In this case the $ is the base currency and the € is the quote currency.
However, there are two prices for each exchange rate:
The selling exchange rate or bid price, and the buying exchange rate or ask rate, which is always higher than the seller's,
We can classify the exchange rates as follows
- Direct exchange rates: In which the dollar is the base currency, such as USD/EUR or USD/JPY
- Indirect exchange rates: In these cases the dollar is the quote currency, such as EUR/USD or JPY/USD
- Cross-currency exchange rates: in these rates the dollar does not appear, but is used in the calculations to find the exchange rate. First the exchange rate of the first currency is calculated against the dollar and then the exchange rate of the second currency is also calculated against the dollar
We say that currency A has depreciated against currency B when the number of units of B needed to obtain one unit of A decreases. In this case, currency B will have appreciated, because with less B we can obtain A.