Exchange Rates

An exchange rate is simply the price of one currency in terms of another. For example, £1 = €1.18 tells you that if you hand over one British pound, you'll get 1.18 euros back.

Here's the mental shift that makes this topic click: stop thinking of currency as "money" and start thinking of it as a product being bought and sold. Just like the market for coffee or trainers, the market for pounds (or dollars, or euros) has a demand curve and a supply curve, and where they cross gives you the price — except here, the "price" is the exchange rate, and the "product" is the currency itself.

• If more people want to buy pounds (demand for £ increases), the price of £ goes up — it becomes worth more.
• If more people want to sell pounds (supply of £ increases), the price of £ goes down — it becomes worth less.

Central banks choose which exchange rate system their country uses. This guide focuses on the floating exchange rate system, where the government does not intervene — the market (demand and supply) is left entirely to determine the price.

A classic exam question gives you an amount in one currency, an exchange rate, and asks you to work out the profit or loss after a currency movement. The trick is to work through it in careful, separate steps — never try to do it all in your head.

Worked Example (from the textbook):

1. Step 1 — Convert €200,000 into £: €200,000 ÷ 1.10 = £181,818.18