What It Is:
An exchange rate between two countries' currencies indicates the value of one currency relative to the other.
How It Works/Example:
On June 16, 2010, the exchange rate between the dollar and the euro was 1.23 $/€. This means that to obtain one euro, you would need 1.23 dollars. Conversely, if you were about to take a vacation to Europe, you could take $1,000 to the bank and receive €813.01.
Exchange rates can be fixed or floating. If a country fixes its currency to that of another country, the exchange rate between those two currencies will not change. If a country has a floating exchange rate, the rate between its currency and any other currency will adjust to market conditions.
Why It Matters:
The exchange rate between two currencies plays a major role in international trade and investment. For instance, if the dollar appreciates, or gains value, relative to the euro, Americans traveling in Europe will have greater purchasing power, but it will be more difficult for the U.S. businesses to export goods.