There are two different ways through which foreign exchange rates are calculated. They are direct and indirect. A direct rate is also called a multiplier in which a value of a stipulated currency is multiplied by the target currency or the quote currency to determine the value of the base currency. For instance, if there is a need to exchange British pound for US dollars, one needs to get the direct exchange rate from a bank or financial services company that provides global foreign exchange services as well. This rate needs to be multiplied by the amount required in U.S. dollars. Now, the figure that comes after this multiplication is the currency exchange London. The method to read direct exchange rate table is from left to right.
An indirect method to calculate currency exchange rate is called a divider. The online currency exchange rate is provided daily, is based on one specific currency, and all values are based on the valuation of a third currency. Therefore, the rate must be divided by the daily rate for the third currency to obtain the actual amount required in the home currency to purchase the secondary currency. Meanwhile, the rate which is used by traders for purchases and traveling is called the market rate. Market rate is always based on the trading completed the previous day. Market rate is typically a rate at which the currency was selling the previous day at the close of trading.
Since exchange rate deals with the global financial market, there are various market forces including demand and supply that affect these rates. One such factor is inflation rates. If UK has comparatively lower inflation rates than the other countries, UK exports will be more competitive and British Pound will be in great demand to buy UK goods. Thus, it is obvious that the countries which has lesser inflation rates are going to witness increase in the value of their respective currencies.
Higher interest rates also contribute in currency's increased value. If UK has higher interest rates than anywhere else in the world, investors are going to be interested in depositing money with UK's financial institutions. Such higher interest rates would help Sterling rise in the foreign exchange market. This is typically known as hot money flows and though a short run factor is of great importance in determining the value of a currency.
Speculation is yet another factor that can turn the logic of the market upside down. For example, if the speculators in the market speculate that the sterling is going to rise in near future, the demand of British Pound will increase to make a profit. Going by the law of supply and demand, the increased demand will result in increased value as well.
Similar to lower inflation rate, there is a factor of attractive and competitive rates of goods. If British goods become attractive and competitive for buyers, the demand for British Pound will automatically increase.
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