How to easily calculate (and understand) exchange rates

So, you've checked the rates with multiple providers and gotten several different answers. How do you calculate the difference in rates? Our guide will give you the lowdown.

Xe Consumer

December 10, 20208 min read

Calculating exchange rates

Did you know that the United Nations recognizes 180 currencies? On any day, each may be the center of thousands, perhaps millions of buy/sell orders. Those trending stronger enable importers to buy goods and services cheaper from sellers governed by currencies going in the other direction. Conversely, net exporter nations take advantage of weaker currencies, selling more to customers living in locations aligned with strengthening coin. Alongside inflation and interest rates, currency exchange rates are a flashing beacon of a country's relative economic health in any dual comparison you choose to make.

Online eCommerce is the lifeblood of business across practically every business category, reducing the great distances between countries and continents to a village-like scale. Alongside this, people are traveling for all kinds of reasons, crisscrossing the oceans to visit family, friends, customers, and other commercial associates. Who would have believed that a factory in Vietnam could sell machine parts to order for an Ohio farming equipment manufacturer as if they lived in the same neighborhood? 

But foreign currency exchange isn’t just a matter of international business. All around the world, people send money overseas to:

  • Support friends and family back home or abroad

  • Deposit in a bank account of their own back home

  • Pay tuition fees, mortgages, debts, and other international bills

  • Purchase property or make investments

Among other things. And when you’re sending money overseas and converting to a different currency, the exchange rate that you get can make a big difference in how much money you need to pay and how much money your recipient gets on the other end.

So, the bottom line is this: currency exchange rates are a big deal, and understanding how to work them out is vital. Domestic people or entities spreading their wings out-of-country should learn the ins and outs of how to work out exchange rates.                                   

So how easy is it to work out exchange rates?

There's no escaping the task of calculating two currencies' relative standing in many situations. The prominent examples are traveling, exporting, importing, and transferring money abroad, which create three immediate questions:

  1. How many different calculation sources can I get answers from?

  2. How reliable is each pertinent to my circumstances?

  3. How often do I have to calculate it for a visualized objective?

Next, there are three important truths to consider about the currency markets and exchange rates.

  1. Currencies fluctuate continuously. Sometimes a few seconds can make a significant difference when committing to a currency swap. 

  2. The currency markets never sleep. They provide a vibrant arena for professionals and banks that trade back and forth in selected currency pairs 24/7/365.

  3. There's a vast difference between:

    1. Trading a currency (as a commodity) and

    2. Using it to bolster one's lifestyle or support interactions with foreign commercial entities. We'll get to the distinctions lower down.

    3. Traveling, Business Transactions, and Transferring Money (hereon referred to collectively as “traditional” transactions)

You can check the exchange rates in a few different places. Some of these places include the Xe Currency Converter, your bank, and good old Google.

The quoted rates you get can vary by a lot. So the one pivotal question is, “can I work out exchange rates myself?" The idea is to avoid getting ripped off and paying too much for currency exchange - especially when large numbers are at stake. 

Here’s something important to know. The most overt rip-off artists (though legal) are generally the kiosks you find at airports or city streets. These operators depend on you being in a bind with too little local currency in the pocket as an inexperienced tourist. However, even with careful preparation, you can lose big time under different circumstances.

How do I calculate the exchange rate?

In short? Here’s the process.

  1. Find the mid-market (or true) rate on the

  2. Get a quote for the same exchange amount from your bank or provider of choice.

  3. Subtract the difference in what you are told you’d receive from each quote (the mid-market rate quote and the send quote).

  4. Add any additional transfer fees to that subtracted amount.

  5. Divide that amount by the number you originally expected to receive to get the percent difference in the rate.

Confused? Here’s an example.

Exchange rate calculation case study: ZAR to USD

Sam T, an ex-South African, now a US citizen, still has business interests in Johannesburg. He relies on 85,000 ZAR (Rands) converted to USD monthly. 

Depending on FNB (a major South African bank), he executes the transactions by wiring the money into his Wells Fargo account in Miami.

On November 28th, 2020, he did a Google search that looked like this - "zar to usd." It flashed the following:

  • Google indicated that Sam T should expect to receive $5,610.47 (i.e., R85,000 x .066).

  • The actual amount Sam saw in Wells Fargo was $5483.87 - corresponding to a USD/ZAR exchange rate of 0.0645 - a reduction of $126.10 (or 2.22%) versus the Google-based expectation.

  • Notably, FNB charged Sam an additional $25 for the transaction separately, making it a $151.10 total deficit.

  • In total, it cost Sam 2.7% for his monthly transfer from ZAR to USD versus the original Google search number (i.e., $151/$5,610).

So, what did Sam T’s currency transaction teach us?

Your quick conclusion is probably that FNB’s quoted ZAR/USD exchange rate was lower than $0.066, to begin with. You’d be right. The Google rate you see is the "interbank" rate - the rate the banks pay when trading with each other (usually in the millions of dollars in a single trade). We often refer to this as the "true" exchange rate, or the mid-market rate. 

The currency gap showing up in Sam's Wells Fargo account was indeed the transacting banks' profit. FNB doesn't disclose what this is, but the margin is not hard to calculate once you have the Google reading. You'll be surprised how few clients ask for the bank rate, getting an unalterable shock later. 

So, in summary, banks, forex specialists, and credit card companies (hereon referred to collectively as "the banks") will never agree with the Google search. They always hover on the wrong side of the equation from the client's viewpoint. Therein lies their monetary incentive to be a middleman. You also have to ask about other fees that reside outside the rate calculation. These institutions rely on foreign currency exchanges and wiring funds for clients as a significant income stream. Hence, all kinds of charges creep into the picture.

What about currency traders?

Currency traders are another kettle of fish. They can make multiple "buy" and "sell" moves between currencies in a day, or even an hour, working around fractions of a percentage (up or down) on trades. The forex market is a massive size - $6.6 trillion daily (based on data submitted by the 2019 Triennial Central Bank Survey of FX and OTC derivatives markets). The big players are commercial banks, central banks, money managers, hedge funds, and organizations hedging transactional risk. 

Although only a fraction of the aggregate forex volume, retail currency traders climb on the inter-institutional bandwagon, getting substantially better rates than described as “traditional” above. That's because they're working on margin (i.e., large leverage allocations) and virtual money transactions in coin pairs. Traders are not moving funds across the world in line with commercial activity. Therefore, many dedicated trading platforms have the latitude to provide:

  • An “Ask” exchange rate (when buying a currency)

  • A “Bid” rate (when selling)

The difference between Bid and Ask is generally lower than one percent for mainstream currencies, like the EURO, GBD (Pound Sterling), or JPY (Japanese Yen). The point is, forex trading is an entirely different conversation. Don't let it confuse the focus of "how to work out exchange rates" outside of this exception (i.e., traditional transactions as defined above.)

“How to work out exchange rates”—summary and conclusion. 

You know that banks and foreign exchange providers will earn a fee from your currency conversion; the only issue is how much is it? When there's profit in the mix, competition rules and exchange rates can vary substantially between providers. So, shop the intended transaction by:

  1. Googling the exchange rate ruling on the day (or checking the Xe Currency Converter), just like Sam did, thus setting the stage with the real rate of exchange.

  2. Requesting various providers to quote their rates and compare them to (a) above. You may be surprised what you find

It may look like a simple process, but it's not so cut and dried. Banks react differently depending on: 

  • How much you're exchanging

  • Which currencies are involved

  • Whether you're changing money online or in-person.

One bank may be the best for one situation but falls apart in another. Therefore, the currency client's selection process is never-ending. It begins anew with every new forex transfer. Also, considering exchange rate volatility, it never hurts to comprehensively test of the many options available to you.

Are you trading currencies, making international payments or transfers, or hedging risk for commercial transactions? Finding the right provider that gives you competitive exchange rates without high margins. Get started with Xe today to see how much you can save on your money transfers.