A conversion rate is the ratio between two currencies used in foreign exchange markets. It is how much of one currency is needed to trade for the equivalent value of another currency. Conversion rates fluctuate regularly for all currencies traded in forex markets. Forex spot prices are quoted continuously, with one day's break each weekend. Conversion rates are essential for international trade, travel, and investment, as they determine the relative value of different currencies and impact the cost of goods, services, and financial transactions across borders.
Key Takeaways
- Conversion rates are how much of one currency is needed to buy one unit of another currency.
- They are the same as exchange rates and spot prices in the forex market.
- Conversion rates are affected by relative supply and demand.
- Central banks and governments adopt policies to respond to the effects of supply and demand that impact the conversion rate.
Understanding Conversion Rates
A conversion rate is how much of one currency is needed for a unit of another currency. For example, if the conversion rate between the U.S. dollar and the euro is 1.20, 1 EUR can be exchanged for 1.20 USD. In other words, you would need 1.20 USD to buy 1 EUR.
Conversion rates can be either fixed or floating:
- Fixed conversion rates are set by a government or central bank and stay constant over time. The USD, for example, functions as the peg for several different currencies.
- Floating conversion rates, or exchange rates, are determined by the foreign exchange market and can fluctuate based on supply and demand, economic factors, and political events.
Because a conversion rate represents the price of one currency in another, it also reflects the relative supply and demand for each currency. The market value of currencies is affected by many things, including a country’s overall economy, central bank interest rates, and government monetary policy.
Suppose the supply of available currency grows more than the number of consumers or investors who demand its use. In that case, its value falls as it becomes less attractive in foreign exchange markets. As a result, that currency’s conversion rate may increase relative to other currencies.
A government or central bank might take steps to increase or decrease the nation’s money supply to regulate the conversion ratio of their currency. This might be done as part of economic stimulus or austerity policies, but supply changes are part of the equation that central banks can control.
A country’s interest rate policy influences demand. If the prevailing interest rate for a currency rises, currency demand could also increase. Individuals and organizations may prefer to hold assets in that currency instead of others.Other factors that can cause conversion rates to fluctuate include balance of trade, perceived inflation risk, and political stability.
Examples of Conversion Rates
The conversion rate represents the relative value between two currencies. It isessentially the measure of one currency against another. As the rate changes, one country's money can become weakeror strongeragainst other currencies.For example, if the USD/Indian rupee (INR) conversion rate is 65.2, then one USD is worth 65.2 Indian rupees.
If the EUR/USD conversion rate falls from 1.20 to 1.10, one euro could only be converted into $1.10 instead of $1.20. In this case, the U.S. dollar is now stronger against the euro, and the euro is weaker against the U.S. dollar. Thisrelative strength means goods and services priced in U.S. dollars cost more when bought in euros. The higher cost would put U.S. businesses at a potential disadvantage, all else being equal, when selling goods in Europe.
Likewise, a stronger U.S. dollar would also make products priced in euros less expensive for buyers in the U.S.In this case, European businesses selling in the U.S. could benefit because prices for their products and services would be lower.
However, if the conversion rate changes in the opposite direction, the U.S. dollar becomes weaker against the euro. If the rate rose from 1.20 to 1.35, one euro could buy more dollar-priced goods and seem less expensive to European buyers. In turn, European businesses selling in the U.S. could be at a disadvantage because U.S. buyers would need more dollars to buy items priced in euros.
How Do You Calculate a Currency Conversion Rate?
To calculate a currency conversion rate, you need to know the exchange rate between the two currencies you are converting. The exchange rate is the price of one currency expressed in another currency. For example, if the exchange rate between the USD and the EUR is 1.20, it means that 1 EUR is equal to 1.20 USD. To convert from one currency to another, multiply the amount of the first currency by the exchange rate. For instance, if you want to convert 100 EUR to USD, you would multiply 100 by 1.20, which equals 120 USD. Conversely, to convert USD to EUR, you would divide the amount of USD by the exchange rate. So, 120 USD divided by 1.20 equals 100 EUR.
What Is the Strongest Currency in the World?
In terms of the currency that can buy the most USD, the strongest currency is the Kuwaiti dinar. As of March 8, 2024, one Kuwaiti dinar is worth $3.26.
Which Is Stronger the euro or Dollar?
Since the EUR's introduction at the turn of the millennium, 1 USD has almost always been worth less than 1 EUR. However, there have been exceptions, including in 2022 and in the EUR's first years.
The Bottom Line
The conversion rate is how much one currency can be exchanged for another. One euro or rupee isn’t equal to one U.S. dollar. One unit of these currencies is worth a certain number of U.S. currency and that number can be found in the relevant conversion rate. If, for example, the euro/USD conversion rate is 1.09, one euro equals $1.09.
Conversion rates aren’t fixed values. They fluctuate as supply and demand for the currencies change. Today 1 euro could buy you $1.09. Next month it could be worth $1.20 or $0.95.
