Foreign currency exchange explained
An exchange rate or the nominal exchange rate represents the relative price of two currencies. For example, the dollar—euro exchange rate implies the relative price of the euro in terms of dollars. Therefore, the exchange rate states how many units of one currency you need to buy one unit of another currency. The consumption basket of a country includes goods and services that are bought or consumed by the average person in this country.
Exchange rate - Wikipedia
Basically, think about the content of your shopping cart when you go grocery shopping, such as milk, bread, eggs, and so on. Other types of exchange rates also exist, including the real and effective exchange rates. In this case, the real exchange rate compares the price of two consumption baskets in a common currency. The effective real exchange rate considers the comparison of the price of the home consumption basket to that of the weighted-average price of the most important trade partners of the home country.
Using the proper terminology is important when referring to a change in the exchange rate. You can think of a floating or flexible regime and a pegged regime. In a floating exchange rate regime, mostly market forces determine exchange rates — in other words, the sale and purchase of the relevant currencies affect exchange rates.
Ignore the nuances among the pegged exchange rate regimes for now and assume that, for the most part, governments set the exchange rate in pegged exchange rate regimes. An exchange rate regime implies whether or how a country decides to manage its currency with respect to other currencies.
Alternatively, a country may decide to exercise varying degrees of control over the exchange rates involving its currency.
Exchange rate - Wikipedia
Appreciation and revaluation have the same meaning: The value of one currency increases against the other. But these terms are used for the floating and pegged exchange rate regimes, respectively. For example, both the dollar and the euro are floating currencies.
If China decreases the yuan—dollar exchange rate from CNY6. In both cases, you need less of the domestic currency to buy one unit of the foreign currency. Depreciation and devaluation also have the same meaning: The value of one currency decreases against the other. Again, these terms are used for the floating and pegged exchange rate regimes, respectively. If China increases the yuan—dollar exchange rate from CNY6. In both cases, you need more of the domestic currency to buy one unit of the foreign currency.
First, various multinational firms care about the changes in exchange rates. Some domestic firms export to or import from other countries. Some firms have licensing and franchising agreements with foreign firms.
Exchange Rate
Some have production facilities in foreign countries, with or without local partners. The important point about international business is that these firms have account payables or receivables in foreign currencies.
A change in the exchange rate makes their payables or receivables in domestic currency smaller or larger in terms of their home currency. Multinational companies cannot ignore the changes in exchange rates, but as an investor, you can, if you want to. You may not follow the changes in exchange rates if your portfolio consists of domestic equity and debt securities.
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