Dollar Rate

What Is the Dollar Rate?

The dollar rate is a currency's exchange rate compared to the U.S. dollar (USD). Most currencies that are traded in international markets are quoted by the number of units of foreign currency per USD. However, some currencies, such as the euro, British pound, and Australian dollar, are quoted in terms of U.S. dollars per foreign currency.

How the Dollar Rate Works

The dollar rate is the rate at which another country's currency converts to the U.S. dollar, so it can be thought of as how many units of currency are needed to purchase 1 U.S. dollar. For example, if the dollar rate to one Canadian dollar is 1.25, then takes 1.25 Canadian dollars to buy one U.S. dollar. If by contrast, the dollar rate on the Canadian dollar is 0.75, then a U.S. dollar could be exchanged for three-quarters of a Canadian dollar.

Importance of the Dollar Rate

The dollar rate reflects the relative value of currencies worldwide. Exchange-rate risk means that changes in the relative value of a given currency to a second currency may increase or reduce the value of investments denominated in that given currency. This is typically the most significant risk for bondholders making interest and principal payments in a foreign currency since the dollar rate affects the investor's true rate of return.

When a currency appreciates, the country becomes more expensive and less internationally competitive. Its citizens have a greater standard of living because they buy international products at reduced prices. When the currency depreciates, local products become more competitive, and exports increase. Incomes do not cover as much when buying international products.

For example, when the dollar rate decreases, U.S. products become cheaper internationally, and U.S. companies increase their exports. Exporting firms hire more workers and employment increases. Because foreign-made products become more expensive when sold in the United States, imports decline. The United States becomes cheaper for foreign tourists, and tourism revenues increase. However, it is more expensive for Americans to travel abroad. Prices of certain imported products increase, leading to higher inflation.

Factors Influencing Dollar Rate

Supply and demand determine the price of a currency. Certain people, firms, or governments buy or sell dollars for other currencies to increase or decrease the dollar's value. For example, American importers exchange dollars for yen at a bank, then buy Japanese cars for sale in the United States, creating a supply of dollars. Likewise, a Japanese importer exchanges yen for dollars and then buys American cars for sale in Japan, creating a demand for dollars.

International investors also influence the dollar rate. For example, American investors exchange dollars for the yen to buy shares on the Japanese stock exchange, creating a supply of dollars. Likewise, Japanese investors exchange yen for dollars when investing in U.S. markets, creating a demand for the dollar.

Governments influence the dollar rate, as well. Each country keeps reserves of gold and foreign currencies for paying international debts, imports, and other purposes. For example, when the Japanese government decides to increase its reserve of dollars, it sells yen for dollars and creates demand for dollars. When the U.S. government increases its reserves of yen, it sells dollars for yen and creates a supply for the dollar. In addition to a government's reserves of its own currency, the perceived political and economic stability of that government and its country will also attract or turn away investors. Countries with less political and economic stability are likely to have a comparatively higher dollar rate.