Exchange Rate

Definition:

An exchange rate is how much of one currency can be exchanged for one unit of another currency.

For example

If the exchange rate of the US dollar to the European euro is 0.81, this means that each US dollar can
be exchanged for 0.81 euros, or every 100 US dollars can be exchanged for 81 euros. Yet, exchange
rates are typically floating, meaning the exchange rate can fluctuate according to the global supply
and demand for foreign exchange.

The law of supply and demand tells us that if demand for an item increases, then the price of that
item generally increases. In contrast, if the supply of an item increases, then the price of that item will
generally decrease. Foreign currency is no different, and exchange rates represent the price at which
foreign currency is purchased and sold.

Exchange rates also affect the things we buy every day and the things we sell to other countries. Since
producers want payment for their goods in their own currency, a change in the exchange rate affects
the price of imports and exports. For example, if the dollar appreciates relative to the euro, then that
bottle of French wine you had your eye on will become cheaper to you.  However, the bottle of
California wine will be more expensive to French consumers and will have a more difficult time
selling there.