An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the figure that tells us how much one country’s currency is worth in terms of another country’s currency.
When people or firms in different countries trade, they have to exchange currency. Let us imagine that a Chinese couple is going to come to the US as tourists. They will have to use their Chinese money to buy American money because American hotels, restaurants, gift shops, etc. will not accept Chinese money. The same happens when WalMart wants to buy a shipment of goods from China. The Chinese company that makes the goods wants to be paid in Chinese yuan because that is the currency that it can use to do things like paying its workers and buying goods from Chinese suppliers. Therefore, WalMart has to use its US dollars to buy Chinese yuan with which to pay the company.
But how many Chinese yuan should one dollar buy? The answer to this is not clear. This is where exchange rates come in. The exchange rate, which is usually set by forces of supply and demand, tell how much WalMart will have to pay for each Chinese yuan and how many yuan the Chinese couple must pay for each US dollar. Right now, the exchange rate is about 6.6 Chinese yuan to one American dollar. That would mean that the Chinese couple would have to spend 6.6 yuan to buy each dollar that they want and WalMart would receive 6.6 yuan for each dollar it spends.
Thus, an exchange rate is the rate at which one currency can be exchanged for another; it tells us how many of one country’s currency you can get in exchange for one unit of another’s currency.
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