How Do Exchange Rates Work? A Simple Guide
An exchange rate is simply the price of one country's currency in terms of another. For example, it tells you how many Indian Rupees it costs to buy one US Dollar. But why do these prices change constantly? It's all about supply and demand on a massive, global scale.
This page breaks down the complex world of exchange rates into simple, easy-to-understand concepts. We'll explore the key factors that make a currency's value rise or fall, from economic health to central bank policies.
The Core Principle: Supply and Demand
At its heart, the foreign exchange (forex) market works like any other market. A currency's price is determined by how many people are buying it versus how many are selling it.
If a country's economy is strong, its exports are in high demand, or its interest rates are high, more investors will want to buy its currency. This increased demand pushes its value up.
If a country is facing political instability or an economic downturn, investors may sell off its currency. This flood of supply into the market causes its value to fall.
Key Factors That Influence Exchange Rates
Several major factors interact to influence the supply and demand for a currency.
Supply and Demand
The most fundamental principle. If more people want to buy a currency (high demand) than sell it (low supply), its value will rise. This is the core of the foreign exchange (forex) market.
Interest Rates
A country's central bank sets interest rates. Higher rates offer better returns to lenders, attracting foreign capital and increasing demand for the currency, which strengthens its value.
Economic Health
A country with a strong, growing economy (low unemployment, high GDP growth) is attractive to investors. This boosts confidence in its currency, increasing its value.
Political Stability & Performance
Countries with stable political environments are seen as safer for investment. Political turmoil or instability can cause investors to lose confidence and sell off a currency, decreasing its value.
See it in Action
Now that you understand the basics, explore the data for yourself. Use our tools to see how currencies have performed over time.