Foreign exchange rates  (Page 6/4)

Introduction

Should you ever find yourself stuck with a mathematics question on a television quiz show, you will probably wish you had remembered how many even prime numbers there are between 1 and 100 for the sake of R1 000 000. And who does not want to be a millionaire, right?

Welcome to the Grade 10 Finance Chapter, where we apply maths skills to everyday financial situations that you are likely to face both now and along your journey to purchasing your first private jet.

If you master the techniques in this chapter, you will grasp the concept of compound interest , and how it can ruin your fortunes if you have credit card debt, or make you millions if you successfully invest your hard-earned money. You will also understand the effects of fluctuating exchange rates, and its impact on your spending power during your overseas holidays!

Before we begin discussing exchange rates it is worth noting that the vast majority of countries use a decimal currency system. This simply means that countries use a currency system that works with powers of ten, for example in South Africa we have 100 (10 squared) cents in a rand. In America there are 100 cents in a dollar. Another way of saying this is that the country has one basic unit of currency and a sub-unit which is a power of 10 of the major unit. This means that, if we ignore the effect of exchange rates, we can essentially substitute rands for dollars or rands for pounds.

Foreign exchange rates

Is $500 ("500 US dollars") per person per night a good deal on a hotel in New York City? The first question you will ask is “How much is that worth in Rands?". A quick call to the local bank or a search on the Internet (for example on http://www.x-rates.com/ ) for the Dollar/Rand exchange rate will give you a basis for assessing the price.

A foreign exchange rate is nothing more than the price of one currency in terms of another. For example, the exchange rate of 6,18 Rands/US Dollars means that $1 costs R6,18. In other words, if you have $1 you could sell it for R6,18 - or if you wanted $1 you would have to pay R6,18 for it.

But what drives exchange rates, and what causes exchange rates to change? And how does this affect you anyway? This section looks at answering these questions.

How much is r1 really worth?

We can quote the price of a currency in terms of any other currency, for example, we can quote the Japanese Yen in term of the Indian Rupee. The US Dollar (USD), British Pound Sterling (GBP) and the Euro (EUR) are, however, the most common used market standards. You will notice that the financial news will report the South African Rand exchange rate in terms of these three major currencies.

So the South African Rand, noted ZAR, could be quoted on a certain date as 6,07040 ZAR per USD (i.e. $1,00 costs R6,07040), or 12,2374 ZAR per GBP. So if I wanted to spend $1 000 on a holiday in the United States of America, this would cost me R6 070,40; and if I wanted £1 000 for a weekend in London it would cost me R12 237,40.