What is an Exchange Rate?

An exchange rate is the ratio at which two currencies are traded. The exchange rate is comprised of a base currency and a counter currency. In a direct quotation, the foreign currency is designated as the base currency and the counter currency is the domestic currency. In an indirect quotation, the domestic currency is designated as the base currency and the counter currency is the foreign currency.

What is a Floating Exchange Rate?

A floating exchange rate is one that is allowed to vary freely, depending on the levels of supply and demand for the applicable currency. For example, the exchange rate between the U.S. dollar (USD) and the euro (EUR) operates under a floating exchange rate system. Therefore, if global demand for U.S. goods and services increases, more people and businesses may need USD to pay for these goods, causing the value of the USD to rise relative to the euro. Or, if demand for the euro increases, perhaps due to a surge in European exports or investments, the euro strengthens against the USD, causing the exchange rate to adjust in real-time.

What is a Spot Exchange Rate?

The spot exchange rate is the exchange rate at which a currency can be delivered immediately. Thus, it is the open market price at which a forex trader would be willing to purchase the currency.