Exchange Rate

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appreciation

currency

depreciation

Exchange rate

There are actually two types of exchange rates that we need to talk about.

For example go to http://www.xe.com/ucc/.  We want to look at the exchange rate from the perspective of a citizen of the United States, so select “United States Dollars – USD” in the “From this currency” box.  Let’s say we are interested in changing our dollars into euros – select “Euro – EUR” from the “To this currency” box.

As of June 12, 2008, 1 USD = 0.648 EUR.  What this tells me is that if I were to take one of my dollars to a currency exchanger, I would get 0.648 euros in return.  Note: Your result will be different, as the currency could have appreciated or depreciated

This is written as e = 0.645 €/$ - you will get 0.645 Euros for every dollar!

If I were to take $100 to the exchanger, I would get 64.5 €.

Now that sounds like a pretty bad trade, but it might not be.

Look at the exchange rate between the dollar and the Hungarian Forint. On June 12th, 2008, $1 will buy 159.6 forint!  With my $100 I could get 15,960 forint!  You could be a millionaire with less than $10,000.

Should we take our dollars over to Hungary right now and live like a king?  Maybe not; we need to know how much things cost in Hungary first, and that is why we need another definition

Let’s say there is only one thing in the world that you would ever need to buy – let’s call that thing a widget.  You can eat it, wear it, or use it to build a house – if you need it the widget can do it. 

So if a widget in the US costs $100 and a widget in Hungary costs 100 forint, then instead of taking my $100 and buying one widget in the US, I’ll take my $100 and exchange them for forint – getting 15,960 forint. I then use that to by 159 widgets – yes life is better.

However, this will most likely not be the case. If I were to go over to Hungary I would probably find that the cost of a widget was 16,000 Ft. If I took my $100 and exchanged them for forint (getting 15,960 Ft.), I would not even be able to buy one widget – I’m not that rich after all!

Illustrated below is the nominal exchange rate for the dollar versus the euro and British pound. A fall in the exchange rate represents a depreciation of the dollar.

Dollar Exchange Rate (Euro per Dollar)

Dollar Exchange Rate (British Pounds per Dollar)

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