How Does Currency Conversion Work?

August 20th, 2021

With a phone in your pocket, currency conversion is not difficult to master. In essence, all you need to do is multiply the amount of one currency with the exchange rate for the other, and you’ve successfully converted the currency.

The only thing that can trip you up is which currency gets multiplied by what rate, i.e. what you are selling and what you are buying. For this reason, we’ve written this step-by-step guide so can always know how to calculate currency conversion in less than a minute.

Determine the Base Currency and Multiply by the Exchange Rate

A forex pair is, just as the name implies, a pair of currencies that you can exchange for one another. It will always contain a base currency and a counter currency. So, USD / EUR is the forex pair. What you need to do is determine what the base currency is. Conventionally, the first currency (so the one on the left) is the base currency.

The base currency is the one you are selling and the exchange is buying. The second one is the counter currency. This way of writing a forex pair is called a direct currency quote and is the most common way they are listed. To convert one currency into another, you multiply the base currency by the exchange rate. So, if you see:

USD / EUR 0.80

USD is the base currency, EUR is the currency you are converting into, 0.80 is the exchange rate (please note it’s not the actual exchange rate, we’re just using it as an example). Thus, if you wanted to exchange 10 USD into EUR, you’d get 10 USD x 0.80 = 8 EUR. Essentially, you are selling 10 USD for 8 EUR.

If the rates in both directions were the same and you flipped the places of the currencies for the EUR to be the base, the forex pair would read:

EUR / USD 1.25

The formula is the same, but now the EUR is the base currency, so you’d get EUR x 1.25 = USD. If we wanted to stick to the same numbers, we’d get 8 EUR x 1.25 = 10 USD. The base formula is really as simple as that.

What if Multiple Rates are Listed?

Currency Conversion

However, you will rarely encounter just one rate listed. Let’s say you are traveling to Europe. More often than not, you’ll see something like EUR / USD 1.25 / 1.30. This difference in the rates is called the bid-ask spread and is how most currency exchanges make a profit.

The formula ‘base currency x rate = counter currency’ still applies. But, if you are to convert using the first rate (1.25) you are selling euros and the exchange office is buying them. The second rate flips it – you are buying for the second rate (1.30) and the exchange is selling.

So, you need 100 EUR for your trip and you need to buy them. You need to multiply 100 EUR by the rate at which the exchange is selling – 100 EUR x 1.30 = 130 USD. So, you’ll pay 130 USD for 100 EUR.

Let’s say another traveler is coming back from their trip and they have 100 EUR leftover that they want to sell. They come to the same exchange to sell their money, thus they use the first rate – 100 EUR x 1.25 = 125 USD. The exchange has now made a $5 profit and that’s how they make money.

A Common Tourist Exchange Scam

In many tourist destinations, you’re likely to encounter a common scam that has to do with the bid-ask spread. Honest offices will list forex pairs in the conventional way – with the direct currency quote. So, EUR / USD 1.25 / 1.30. Often, they may even write something like:

A Common Tourist Exchange Scam

The second way (the one on the right in the table) to list a forex pair is called an indirect quote, where you buy the currency on the left, as opposed to selling it, as is the case with a direct currency quote. An indirect quote is less common, but that’s no issue if it’s clearly marked with ‘we sell’ or something similar.

The scam functions like this: 1. The exchange office has bad rates, with a very wide bid-ask spread; 2. In big, capital letters they promote the indirect quote without marking it with ‘we sell’, while placing the direct quote somewhere in miniature letters; 3. Most people assume it’s a direct quote, don’t calculate the rate and don’t count their money, and leave with much less than is normal.

For example, if an indirect currency quote said USD / EUR 1.00 and you don’t realize it, you would expect to pay 1 USD for 1 EUR, as that is the common way of listing exchange rates. However, somewhere below in small letters, they list USD / EUR 0.60, so you end up with 0.60 EUR instead of the 1 you were expecting.

While this seems simple, people often don’t pay attention to how much money they got until well after they leave, and that’s what the scammers count on. And while these types of places get shut down quite regularly, new ones always pop up, so pay attention to the currency conversion and always count your money right there in the exchange office.

Is There a Simpler Way to Do Currency Conversion?

Absolutely. For one, you can use our online currency converter and not worry about base currencies, direct or indirect quotes, or anything else. Choose the currency and amount you want to convert, and it will be automatically calculated. But, where to exchange currency if you’re traveling abroad?

Why not right here in the U.S.? Once you have decided how much you want to buy or sell, you can order your currency online and US First Exchange will safely deliver your money straight into your hands, well before you go on your trip.

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