Don't Get Taken: How to Evaluate an Exchange Rate

By Claire Millard on 14 June 2016 0 comments

Currency exchanges should be simple transactions, requiring only very basic elementary school math. Multiply a couple of numbers and you are done, ready to take your trip abroad free from worry.

But there are so many choices of exchange services — online, in banks, and at the airports — all offering slightly different rates and service packages. Not only is it draining to figure out which to choose, but it also makes it hard to know whether or not the price you are being charged to switch your hard-earned cash is fair.

Check out this quick summary guide to help you calculate and find a fair exchange rate. (See also: Travel and Money: Using Pre Paid Travel Cards)

Why Is Currency Exchange So Confusing?

Some of the confusion around exchange rates is hard wired into the system. Rates vary day by day — and minute by minute — depending on trades going on around the world. The range of factors that can influence an exchange rate runs from macroeconomic and political trends, to the quirks of individual high value trades. Concerns about the stability of a currency can cause it to tank, while some good news can see it shooting up as investors want to buy in.

Aside from the vagaries of the market, the other major factor influencing rates are the banks and exchange services, themselves. The rates on offer at your main street bank, when exchanging relatively small sums, are quite different from the rates that would be offered to a trader dealing on a daily basis in huge volumes.

And because different banks and platforms apply different percentage markups to the exchange rates that are available on the open market, the end result is that there are pretty much as many rates as there are banks. So amid all the moving parts, how do you know if the rate you have been offered is actually fair?

Do the Math

This is the elementary level bit. Let's recap a bit of your childhood math.

If you would like to change some money from dollars to euros, you will find the exchange rate, depending on the day and bank rate, listed something like this: 1 USD = 0.89EUR. This means that one dollar will buy you 0.89 euros. If your budget for your super luxury trip is $2,000, the calculation is as follows:

2,000 X 0.89 = 1,780

So your $2,000 will buy you €1,780.

Naturally, you can do the same math backward. If you know the amount in euros that you need for your trip, then you simply find the correct rate, which will look something like this: 1 EUR = 1.12USD. If you know you need €3,000 for your trip, then the sum looks like this:

3,000 X 1.12 = 3,360

And your trip will cost you the grand total of $3,360.

That's the easy part. But how do you know if the rates that are listed in your bank are actually good or not? Crack out the calculator again because there's more math coming.

Banks and the Mid-Market Rate

To know if the rate your bank has on offer is any good, you can compare it to the midmarket rate to work out the percentage markup they are adding for their own profit. Here's how:

Find the Mid-Market Rate

It is easy enough to find the live market rates for most currency pairings from Yahoo! Finance. Simply find the currency pair that you want to exchange between, which will be expressed something like this: GBP/USD, or USD/EUR.

Check the Bank Rate

The market rate you will find in the step above is not the same as the rate you can get from walking into the bank. This is because the market deals with huge trades, and offers favorable rates for volume. The actual rate available to you will depend on the amount you want to exchange, and other factors, like whether you want the money immediately, or can wait.

Pick a rate to compare. Let's say we are changing dollars to sterling, for a trip to London. The market rate we found is USD/GBP 0.68. However, the rate offered by an online exchange service is USD/GBP 0.65.

Do the Math

The markup applied by the online exchange service is the difference between the two rates — but you need to turn this into a percentage to compare it.

The difference between the rates is: 0.68 - 0.65 = 0.03

To turn this into a percentage, divide it by the market exchange rate and multiply by 100:

0.03/0.68 = 0.04411765 (X 100) = 4.41%

This is a real example, and shows the huge markup that some online exchange services charge — exactly why you need to watch out! In this case, the service applied a markup of 4.4% to allow you to change your cash — a hefty fee. But now that you know the math, you can quickly compare rates — and choose the service that offers the best value.

So What Do I Do?

Knowing that some currency exchange platforms are charging a big fee is one thing. More useful is knowing what to do about it, so you can knock it off the list of things you might be overcharged for on vacation. There will be a markup on the market rate, but keeping this as low as possible will mean you get more bang for your buck.

Research is your friend, especially if you have some time to observe the rates and get a feel for what the market is doing. Currency converters available online are the best way to keep an eye on the fluctuations in rate. If you have the luxury of time, then you can wait for the rate to improve before making your exchange.

The biggest threat to your hard-earned cash is the fact that many banks and platforms hide fees and charges in small print. So for example, a bank might claim to charge no commission — but the chances are that they adjust their rate to mean you pay over the odds for the currency. Or you might find that the package of "premium" perks, like having your cash delivered securely to your home, or being able to sell your spare change back to the bank, turn out to be more expensive than they are worth. Be really clear on the services you need, and you won't be tricked into thinking a package is a great deal when it is not!

How do you make sure that you get the best deal possible when exchanging your cash for vacation? Let us know in the comments.

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