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Money conversion: how to calculate exchange rates

Posted by MoneyNetint Staff on May 5, 2017

money conversion

Introduction - calculate exchange rates

An exchange rate is the cost of exchange from one currency to another. It’s a constantly revolving process as traders, companies, and institutions buy and sell currencies 24 hours a day during the week. In essence, money conversion is a simple task that has a much more complicated background. Most of all, it can be a bit confusing for those not familiar with the general principle and all the finer aspects of it, which is why this post will address the issue of calculating exchange rates, as well as provide additional tips and insights. Here we go.


Understanding exchange rates

Since exchange rates are a rather common sight, they can be found in different places such as: 

  • commercial banks,
  • specialty websites like xe,com and
  • money processing services. 

Rates are always given in pairs called currency pairs, because the value of one currency is relative to another. Among the most frequently quoted currencies are the U.S. dollar and euro (the pair we’ll use as an example later on), likely due to the fact that central banks around the globe use them as a reserve currency. A quick overview - an EUR/USD exchange rate of 1.10 mean it takes 1.10 US dollars to buy 1 euro.

 

Due to numerous factors like supply and demand, various economic indicators like unemployment and stock prices, commercial activity and more, the rates are in constant fluctuation. The fluctuations happen all the time, resulting in very small changes known as pips. This is where things get interesting as on a glance, a pip’s worth, let’s say $0.0001, looks tiny. However, when accounting for the big picture - large transaction amounts, constantly changing rates and so on - the money soon adds up significantly. So, with such variable nature, how to know which exchange rate is fair and gets you the best deal? 

How to calculate exchange rates

While simple money conversion like converting $100 to a foreign currency looks benign enough, converting currencies when analyzing foreign stock's financial statements (the report card of a  business) can make all the difference to international sellers and investors. Let’s head on to our example.

 

So, an EUR/USD exchange rate is 1.10, a nice, round-enough figure. Converting $100 to euros would go like this:

 

  • $100 / 1.1 = 90.90e

Converting euros to dollars is a reverse process and includes multiplying the number of euros with the exchange rate:

  • 100e * 1.1 = $110

If that looks quite simple, it’s because it is. So, where is the problem? Apart from getting the most favorable exchange rates, there is another layer that needs to be accounted for - fees.

The main culprits, in this case, are the banks. They offer exchange rates that significantly differ from the actual market. Along with currency exchanges and Forex specialists, they take a percentage off every exchange they make for you and even add additional costs in order to make a profit. 

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How to spot the differences?

In order to figure out the differences in rates offered by different banks or money exchange services, you can calculate the markup being added. On top of that, you should also check for any extra fees per transaction.

We’ll use the 1.10 EUR/USD rate once more. Let’s say that a bank is offering a 1.15 rate. Because every bank takes a cut, you'll get a different exchange rate than the rate you find online almost every time. Apart from varying from bank to bank, the rates will also depend on factors like the amount you want to exchange, the currencies, are you changing online or in person and such. Sticking with our example, it’s clear that there is a 0.05 difference in rates. To turn this into a percentage, divide the original exchange rate and then multiply by 100:

  • 05 / 1.10 = 0,045 x 100 = 4,5

This means that a bank would be charging a 4.5 percent markup for conversion services, not counting additional fees which are sure to follow.

The solution

Generally, non-bank providers are a much better choice, provided you avoid specialist currency exchange companies who do this for a living. These non-bank providers charge an average of 0.9% on $10,000. When compared to the banks and their charges that can amount up to four times more, this is a real blessing. Since virtual money is involved, the administration costs are smaller and you get a quicker and easier access to your converted funds.

 

However, among the non-bank providers such as money processing businesses, there is also a lot of variation. Conversion fees alone range from 1 percent to 2.5 percent (PayPal). You cannot avoid a markup in this situation (a company has to make a profit) but you can pick the best deal for yourself. Take MoneyNet for instance. We are cheaper than both banks and the vast majority of similar companies like ours to our due to the fact that we make money on the exchange rate spread, the difference between the buy and sell rate. Thus, we charge a smaller margin and profit than other brokers and banks without any extra fees, charges, and affiliate commissions.

 

The bottom line here is that even the smallest fluctuation in a currency can have a big impact in the end. For a seller that has borrowed $1,000 for each $1.00 committed to a trade or an international investor looking to calculate the impact of a $0.0001 difference on $1 billion in revenue, the results matter too much to convert money without thinking this through.

Summing up

Money conversion is a delicate process due to constantly changing exchange rates. In the end, the way you manage your money can make a big difference regarding your profit margins. Once you understand the nature of the process, it’s easy to calculate exchange rates and find the best ones. The solution for your conversion needs is a specialized independent payment company and platform with an innovative model of operations. It offers reasonable exchange rates and fees but be sure to check the fine print. You’ve worked hard for your money so don’t get caught paying high bank charges and exchange rates but rather find the best deal there is.


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