Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

International Currency Exchange Rate

What it is:

An international currency exchange rate is the rate at which one currency converts to another.

How it works (Example):

For example, if the international currency exchange rate for one U.S. dollar to one Canadian dollar is 0.75, then one U.S. dollar can be exchanged for 0.75 of a Canadian dollar.

International currency exchange rates change either because the demand for a particular currency changes or, in some cases, a government forcibly sets the rate. The interest rates between two countries often reflect expected changes in the international currency exchange rate between them. For example, if interest rates are higher in Canada, the U.S. dollar will probably decline in value relative to the Canadian dollar. (This is because when interest rates increase in a particular country, international money flows into that country to capture the higher yields. This pushes the value of that country's currency higher.)

The Financial Accounting Standards Board and Generally Accepted Accounting Principles (GAAP) require companies to report the effects of gains and losses from currency conversions related to the normal course of business, when translating a foreign subsidiary's financial statements to the company's primary currency, or when liquidating or purchasing another entity.

Why it Matters:

International currency exchange rates reflect the relative values of currencies around the world. Exchange-rate risk, also called currency risk, is the risk that changes in the relative value of certain currencies will reduce the value of investments denominated in a foreign currency. This is often the single biggest risk for holders of bonds who make interest and principal payments in a foreign currency, and thus international currency exchange rates matter because they affect the amount of money the investor actually sees at the end of the day. This in turn determines what the investor's rate of return ultimately is.

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