Understanding Conversion Rate

by Investing School on June 17, 2011

When participating in foreign exchange of currencies, there are some pretty basic concepts one must understand. The conversion rate is the ratio at which one currency can be traded for another. You may also hear the conversion rate referred to as the exchange rate. As in any other ratio the rate is evaluated in a comparative statement.

If the trader wishes to trade Hong Kong Dollars (HKD) for United States Dollars (USD), a conversion rate for USD to HKD of 7.75 means that one U.S. dollar can be converted to 7.75 Hong Kong dollars. The higher the conversion rate between the currencies, the more currency can be bought per unit of the base currency. This also means that, in this case, the HKD has a lower value in relation to the USD.

The value of a country’s currency and the conversion rate is dependent upon numerous factors. The difference in interest rates between the two countries is one such factor, while the perceived stability of the national economy is another.

There is an actual convention determining which currency is considered the base currency and which the quote currency in every transaction. The basis of this convention was intended to reduce confusion in trades, but there are some holdouts. For example, the Japanese usually quote their currency as the base, even when the value of the Yen is lower than the currency being purchased.

Some countries attempt to manipulate the value of their currency. China is one of the countries most frequently accused of doing so. A low rate of exchange will drop the price of a country’s goods abroad, while raising the prices of imported goods at home. This discourages the purchase of foreign goods, creating an imbalance in trade.

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