What is currency exchange rate?

Naren wants to travel to Japan. He looks forward to staying there, eating local food, and of course, buying gifts for people at home.

But when he lands there, he realises he cannot pay in rupees!

This is because Japan uses a different currency. The Japanese currency is called Yen. It looks like this:

Nonplussed, he asks the storekeeper how he may get some “Yen”.

The storekeeper guides him to a special type of shop.

This shop accepts Indian rupees and gives him Japanese Yen.

Such a store is called Currency Exchange – where you can exchange one currency for another.

Naren gives the person at the counter 100 rupees, expecting to get 100 Yen in return.

But he is surprised to get 173 Yen back.

Why did this happen?

All currencies are not equal.

The rate at which one currency is exchanged for another is called their exchange rate.

In this case, 100 INR = 173 Japanese Yen.

What decides this exchange rate?

Remember the law of demand? When the demand for something goes up, its price will also go up. We all experience law of demand around us. It is the same with currencies too! A currency that many people need will obviously get a premium on exchange compared to, let’s say, a currency that no one wants.

Countries buy currency for their own forex reserves. People who do international trade buy currency so that they are able to pay for their imports.

After India started buying Russian oil in roubles instead of dollars, the exchange rate of rouble went up – because more roubles were now needed by India (and other countries buying oil in roubles).

Dollar is the currency of global trade. When two countries buy or sell things to each other, even if dollar is not the currency of either country, they have to pay in dollars. That is why dollars are usually expensive. (Currently, one US dollar is about 75 Indian rupees).

Interesting trivia

At this time – August 2023, the Iranian Rial (IRR) is the cheapest currency in the world (1 USD = 42,000 IRR), while the Kuwaiti Dinar (KWD) is the most valuable. (1 USD = just 0.31 KWD).