What is a Currency Exchange? - Robinhood (2024)

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A currency exchange is like getting tokens at an arcade…

When you go to an arcade, you usually can’t put quarters into the machines to play games. Most arcades make you go to a token machine, where you put in money and receive special tokens to use at the arcade. A currency exchange is similar. You can’t use dollars in Japan or euros in Russia. You have to bring your currency to a currency exchange to get the money that you can use in the country you’re visiting.

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A currency exchange is a business that helps travelers exchange different types of currencies. Different countries use different currencies. For example, the United States uses dollars and much of Europe uses euros. Typically, businesses will use the currency issued by the local government, though in some cases businesses may be willing to make transactions in a few different currencies.

If you travel to a country that uses a different currency than the one from your home country, you most likely won’t be able to use the money you brought with you at the majority of businesses. Instead, you need to visit a currency exchange to trade in your currency for the one used in the country you’re visiting. For example, if you visit Japan from the U.S., you’ll have to trade your dollars in for yen. Some currency exchanges even let you exchange traditional currencies for cryptocurrencies.

There are also other ways to get local currency. Many banks will let you use your debit card in foreign countries to withdraw money in the local currency, even though your account holds a different type of money. You’re exchanging the currency in your bank account for a different type of money.

Currency exchanges list the exchange rate between different currencies. Often, currency exchange booths in airports and other travel hubs will provide a slightly worse exchange rate than is available elsewhere, or charge high fees, to help them earn a profit from exchanging currencies.

The exchange rate between currencies varies with a huge variety of factors and changes daily or even hourly. For example, on June 1st, 2022 one euro was worth $1.0653; two days later, on June 3rd, one euro was worth $1.072. A month before that, on May 4th, the exchange rate was one euro to $1.0511.

Currency exchange works by letting you convert one currency, like dollars, to another, like euros. You give a currency exchange an amount in one currency, and they give you back an amount of a different currency with a similar purchasing power, subtracting out any fees or other charges.

By exchanging currencies, travelers can purchase goods using the currency that’s most frequently accepted wherever they are visiting.

Some people trade on the foreign exchange (forex) market to try and make money based on fluctuating exchange rates. For example, if a forex trader predicts that the ruble is about to gain value compared to the dollar, they may exchange dollars for rubles, wait for a short time, then exchange their rubles for dollars. If the ruble gained value (or the dollar lost value), the trader winds up with more dollars than they had at the start.

Forex traders may also look for arbitrage opportunities, where they can make a profit by taking advantage of differences in exchange rates between multiple currencies or between different exchange markets.

Forex trading, unlike stock markets, is open 24 hours a day, so traders can make exchanges whenever they like. However, the Securities and Exchange Commission still regulates and monitors forex markets.

Many currency exchange rates are floating, meaning they move independently of other currencies. Calculating these exchange rates is highly complex and depends on a variety of factors, including:

• The purchasing power of a currency
• Inflation
• Supply and demand
• Import and export ratios
• Foreign investment
• Fiscal policy

For example, if a currency undergoes major inflation, the exchange value of that currency will likely drop. Imagine a scenario where the dollar experiences severe inflation and becomes worth half of what it was worth before. If before you could trade $100 for 90 euros, now you‘d only get around 45 euros (assuming the euro’s value stayed constant), because the dollar lost half of its purchasing power.

Demand for a currency also impacts its exchange rate. Many countries in Europe use the euro as their currency. Businesses expect payment in euros and governments make citizens pay taxes in euros. This means that there is a large demand for euros, which increases the currency’s value. If fewer businesses accepted euros or governments started letting citizens pay taxes in other currencies, there would be less demand for euros, and their value might drop.

Unlike floating currencies, some other currencies are pegged or fixed. A pegged currency always has the same exchange rate with the currency to which it’s pegged. Typically, countries that peg their currencies do so with major world currencies like the U.S. dollar or the euro.

Pegging a currency to another one gives some benefits. One major benefit is certainty. If you know that 3.67 dirham (from the United Arab Emirates) always gets you one American dollar, since that’s the rate at which it is pegged, then it’s easy to do business in dollars or in dirham, since conversion is simple.

However, pegging a currency has drawbacks. Currency values fluctuate based on real economic phenomena, like inflation and purchasing power. If a currency is pegged, the underlying values of each currency can move from the exchange rate, creating a situation where you always gain or lose purchasing power by exchanging between currencies. This can result in black markets for the currencies involved, where they trade for their true values instead of the pegged values.

Today, most currencies use a hybrid system called a floating peg. The values of currencies can change in relation to each other, but some level of currency pegging provides stability that can stop the value of one type of money dropping or rising quickly due to a financial panic.

Like most things in the world of finance, exchanging currencies is rarely free. Some currency exchanges charge a fee for their services while others give customers an exchange rate slightly worse than the one available on the open market, letting the business earn a profit.

For example, currency exchange kiosks at airports and other travel hubs typically offer poor exchange rates.

One of the best places to exchange currency is your local bank. Many banks will let you withdraw money in major foreign currencies in advance of your travels. You can also use your debit card to withdraw local currency from an ATM even if you only have U.S. dollars in your account.

Another option is to use your credit card to make purchases. Many card issuers will automatically convert currencies for you when you swipe the card. For example, you can use the same card you use in the United States to make a purchase in Canadian dollars. Just make sure to check the fine print of your card agreement, because some card issuers charge a foreign transaction fee for this service.

Exchanging currency for free is difficult, but not impossible.

If you make a large currency conversion, your bank may be able to make the conversion for you free of charge. For example, Bank of America doesn’t charge for conversions over $1,000.

If your bank reimburses ATM fees (particularly for ATMs in foreign countries) and does not charge foreign transaction fees, you can also use your debit card to make a free withdrawal from your account in the local currency.

Currency exchange rates can change by the minute. Currencies are traded 24 hours a day. The rate may change by only a few cents from one day to the next, or larger fluctuations may happen rapidly. If you’re exchanging currency, always check the rates in real time.

Here is a sampling of currency exchange rates as of October 5, 2022:

• 1 AUD = 0.6494 USD
• 1 CAD = 0.7390 USD
• 1 CNY = 0.0141 USD
• 1 DKK = 0.1341 USD
• 1 EUR = 0.9973 USD
• 1 GBP = 1.1429 USD
• 1 HKD = 0.1274 USD
• 1 JPY = 0.0069 USD
• 1 MXN = 0.0500 USD
• 1 NZD = 0.5751 USD
• 1 NOK = 0.0955 USD
• 1 SGD = 0.7029 USD
• 1 SEK = 0.0920 USD
• 1 CHF = 1.0204 USD
• 1 THB = 0.0267 USD

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