You may already be familiar with the concept of foreign exchange but not know where to start when trying to dive deeper into learning about it. We’re here to help explain foreign exchange rate basics as well as related terms.
Foreign exchange rate, defined
The foreign exchange rate, also known as the FX rate, is the ratio between a pair of currencies that shows how much of one exchanges for the other. Due to both the ebb and flow of currency demand and round-the-clock trading, FX rates fluctuate regularly. These rates are set and quoted by the foreign exchange markets.
The foreign exchange market is the world’s largest and most liquid financial market, with volumes exceeding all global equity and fixed income volumes combined. Trading takes place 24 hours a day, opening Monday morning in New Zealand and closing Friday evening in the United States.
For easy identification, each currency is assigned a unique currency code consisting of three letters. For example, US Dollar is USD, Chinese Yuan is CNY, and the Great Britain Pound is GBP.
Understanding FX quotes
Two different styles exist for displaying currency: American Currency Quotation and European Currency Quotation. The American Currency Quotation shows how many USD it takes to purchase one unit of foreign currency. For example, EUR/USD = 1.10 => 1.10 USD per 1 EUR.
On the other hand, the European Currency Quotation shows how much foreign currency is needed to purchase one unit of USD. For example, USD/JPY = 110 => 110 JPY per 1 USD. Most of the world’s currencies follow European Currency Quotation for trade purposes, with the exception of EUR, GBP, and AUD, among others.
Bid and ask quotes
A market maker is a company or person that provides the market with two prices: a buy and sell quote for a currency. So, if the rate for EUR/USD is 1.09/1.11, then 1.09 is the market maker’s bid quote, which is the market maker’s buying price for the base currency (EUR in this case). 1.11 would be the market maker’s sell quote, which is the market maker’s selling price for the base currency.
FX risk and hedging
FX rates fluctuate regularly, which leads to an uncertainty of outcome. In order to reduce or eliminate uncertainty caused by FX rate fluctuations, a company can implement FX hedging, which involves taking on a risk to neutralize another one. Contracts used for FX hedging include FX forwards, swaps, and options.
How to review Flywire’s FX rates
Flywire and its locally licensed partners offer competitive exchange rates that are often lower than what banks offer for retail consumers. It’s important that payers who want to review Flywire’s rates do so by comparing them to their bank’s retail rates, rather than those found online. The exchange rates posted on many websites online are often the mid-market rates, which are not always available to the retail consumer. Because exchange rates are in constant flux, the rates should be compared at the same time ideally.