Exchange rates for dummies

When sending money abroad it is very important to understand how exchange rates work. Before becoming an expat I had vague souvenirs them from my economics classes in high-school. As I hated it, I had a very bad understanding of exchange rates but it all changed when I first needed to send money back home.

exchange-rates-for-dummies

 

Exchange rate definition

First of all, no one is able to evaluate a currency in absolute terms. Therefore the value of a certain currency is given in relation with another one. This relation is called exchange rate and it represents the amount of foreign currency you can buy with one unit of your currency. So USD-EUR will be different from USD-GBP for example.

Here is how you see it written: GBP/USD = 1,289. It means that with 1 British pound you can get 1,289 US dollars.

All exchange rates are defined on the foreign exchange market. But states have the authority to decide which exchange rate regime to choose. There are two options here:

  • Fixed: it means that the currency rate is fixed compared to another one.
  • Free-floating: the currency rate is changing depending on the demand and off on the foreign exchange market.

The importance of exchange rates when sending money internationally

Another characteristic of exchange rates is that they are unstable and can change very quickly and it is not always in your favor. This means that there are good moments to make international transfers and bad ones.

What happens when you transfer money with your bank for example? Most of the time you will not have any visibility on the exchange that they have applied and it is generally very poor compared to the real one.

It is the same when you are using money transfer operators such as Western Union. Most of the time they sell you free international transfers with no fees. Interesting isn’t it? It is actually not free because they make money on the exchange rate, applying poor ones.

As you have understood, paying attention to exchange rates when sending money abroad is crucial. Especially if you want to optimize your transfers.

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