Establish Money Market Equilibrium
Predict Changes in the Euro–Dollar Exchange Rate
Attract Foreign Investors with Soft Pegs

Exchange Rate as the Price of Foreign Currency

The dollar–euro exchange rate implies the price of the euro in dollars. You can use this exchange rate to convert a dollar amount into euros, or vice versa.

Suppose you’re an American exporter of backpacks. The importing firm in Germany wires a payment of €135,000 to your bank for the August 2012 shipment of backpacks. The bank deposits the money in your account as dollars, at an exchange rate of $1.24. What’s the total number of dollars deposited into your account?

The exchange rate is defined as $/€, and the amount of money is denominated in euros. You cancel the euros to find the amount in dollars by multiplying the euro payment by the dollar–euro exchange rate:

image0.jpg

or

€135,000 x $1.24 = $167,400

In this case, your bank deposits $167,400 into your account.

Suppose you’re an American importer of French cheese. You receive a new shipment for which you have to pay the French firm $185,000. If the French firm’s bank applies the dollar–euro exchange rate of $1.24, how many euros does the French firm receive?

Again, the exchange rate is defined as $/€, and the amount is denominated in dollars. You cancel the dollars to find the amount in euros by dividing the dollar payment by the dollar–euro exchange rate:

image1.jpg

or

$185,000 / 1.24 = 149,194

The German firm receives €149,194 from this transaction.

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