Exchange rate

An exchange rate states how much of one currency it takes to buy a unit of another — for example, a rate of 150 yen per U.S. dollar means one dollar buys 150 yen. Exchange rates are set in the foreign exchange (forex) market, where currencies are traded around the clock by banks, businesses, investors, and governments.

Under a floating system, a currency's value moves with supply and demand. Demand for dollars rises — and the dollar appreciates — when foreigners want to buy U.S. goods, services, or financial assets; higher relative interest rates and lower relative inflation both attract that demand. When a currency appreciates, its exports become more expensive to foreign buyers and imports become cheaper, which tends to shrink net exports. A depreciating currency does the opposite. Some countries instead fix or manage their exchange rate by buying and selling reserves.

Exchange rates matter to investors as well as trading economies. Anyone holding foreign stocks, American depositary receipts (ADRs), or international bonds bears currency risk: even if the foreign asset gains value in its home currency, a decline in that currency against the investor's home currency can erase the profit.

Exchange rates are tested from several angles: AP Macroeconomics covers the foreign exchange market and appreciation/depreciation graphically, the CGMA/CIMA business economics syllabus covers exchange rate systems and currency risk, and the Series 66 tests currency risk in ADRs and international investments.