Currency Exchange Rates - Overview, How It
                     CURRENCY 
EXCHANGE 
RATES - 
OVERVIEW, HOW 
IT WORKS, 
IMPORTANCE
WHAT IS AN 
EXCHANGE RATE?
An exchange rate is the rate at which one 
currency can be exchanged for another 
between nations or economic zones. It is used 
to determine the value of various currencies in 
relation to each other and is important in 
determining trade and capital flow dynamics.
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UNDERSTANDING 
EXCHANGE RATES
Exchange rates are quoted between two 
currencies. For example the exchange rate as 
of late August 2020 is 1.31, which shows that 
CAD 1.31 is received if exchanging USD 1.00.
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FACTORS 
IMPACTING 
EXCHANGE RATES
The rates are impacted by two factors:
1. The domestic currency value
2. The foreign currency value
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DIRECT 
QUOTATION VS. 
INDIRECT 
QUOTATION
• Direct quotation of exchange rates involves quoting 
the price of a unit of foreign currency directly in terms 
of the number of units of domestic currency that are 
exchanged.
• Indirect quotation of exchange rates involves 
expressing the price of a domestic currency in terms 
of the number of units of foreign currency that are 
exchanged.
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CROSS RATES
• Cross rates are a method of quoting exchange rates in 
which various foreign currency exchange rates are 
used to imply a domestic exchange rate, e.g., if you 
wanted to determine the EUR/USD exchange rate but 
can’t access a direct quote. 
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IMPORTANCE 
OF EXCHANGE 
RATES
INTEREST RATES
• Changes in interest rates impact currency value and 
exchange rates. All else being equal, a higher interest 
rate in a domestic country will increase the demand 
for a domestic currency since more foreign investors 
will seek to invest at the higher interest rate, thereby 
investing foreign capital into the domestic currency. 
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INFLATION RATES
• Changes in inflation rates impact currency value and 
exchange rates. All else being equal, a higher inflation 
rate in a domestic country will decrease the demand 
for the domestic currency since the value of the 
currency depreciates relatively faster over time than 
other foreign currencies.
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GOVERNMENT 
DEBT
• Government debt is the amount of debt owed by a 
federal government. It impacts currency value and 
exchange rates since a country with higher debt is 
less likely to acquire foreign capital, which, in turn, 
leads to inflation. 
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POLITICAL 
STABILITY
• The political state of a country influences the currency 
value and exchange rates since a country with higher 
political turmoil is less likely to attract foreign 
investors. 
• Political instability fosters more risk for investors, as 
they are unsure of whether they will see their 
investments protected via fair market practices or a 
strong legal system.
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EXPORT OR IMPORT 
ACTIVITIES
• A country’s net exports or imports impact currency 
value and exchange rates. A domestic country that 
exports more goods than it imports will experience a 
higher demand for its currency, and thereby, will see 
its exchange rate increase relative to other foreign 
currencies.
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