Dubai: Currency exchanges should be simple transactions, requiring only very basic math. Multiply a couple of numbers and you should be done, ready to either remit money back home or use cash in your trip abroad, stress-free. But is it?
There are so many choices of exchange services — online, in banks, and at the airports — all offering slightly different rates and service packages.
So not only is it a hassle to figure out which to choose, but it also makes it hard to know whether or not the price you are being charged to switch your hard-earned cash is fair.
Here’s a quick summarised guide to help you calculate and find a fair exchange rate.
Why is currency exchange so confusing?
Some of the confusion around exchange rates is hard wired into the system. Rates vary day by day — and minute by minute — depending on trades going on around the world.
The range of factors that can influence an exchange rate runs from macroeconomic and political trends, to the quirks of individual high value trades. Concerns about the stability of a currency can cause it to tank, while some good news can see it shooting up as investors want to buy in.
Aside from the whims of the market, the other major factor influencing rates are the banks and exchange services, themselves.
The rates on offer at your main bank, when exchanging relatively small sums, are quite different from the rates that would be offered to a trader dealing on a daily basis in huge volumes.
And because different banks and platforms apply different percentage mark-ups to the exchange rates that are available on the open market, the end result is that there are pretty much as many rates as there are banks.
So amid all the moving parts, how do you know if the rate you have been offered is actually fair?
Doing the math is fairly simple, but essential
This is the rudimentary bit of calculation. Let's recap a bit of this much-needed math.
If you would like to change some money from dollars to euros, you will find the exchange rate, depending on the day and bank rate, listed something like this: 1 USD = 0.89 EUR.
This means that one dollar will buy you 0.89 euros. If your budget for your super luxury trip is $2,000 (Dh7,346), the calculation is as follows: 2,000 X 0.89 = 1,780 EUR
So your $2,000 will buy you 1,780 euros.
Naturally, you can do the same math backward. If you know the amount in euros that you need for your trip, then you simply find the correct rate, which will look something like this: 1 EUR = 1.12USD
If you know you need 3,000 euros (Dh12,912) for your trip, then the sum looks like this: 3,000 X 1.12 = 3,360 EUR
So your trip will cost you a grand total of $3,360 (Dh12,342).
That's the easy part. But how do you know if the rates that are listed in your bank are actually fair or not? You will need the calculator again because there's more math coming.
Do you know how the exchange rate is set?
How many dollars go into a euro? How many euros go into a yen? How many yen go into a pound?
If you’re thinking ‘the exchange rate decides all that,’ then you’re right. But who decides the exchange rate?
Banks and other providers all set their own rates, so there’s no one answer. But for all intents and purposes, there is a ‘real’ rate out there. It’s called the ‘mid-market’ rate.
Mid-market rate: The ‘real’ exchange rate
Bankers and currency traders buy and sell currencies all the time in the open market.
Take any currency, and there are prices they’re willing to pay for it, and prices they’re willing to sell it for. The midpoint of these prices is the mid-market rate.
Since that’s the rate the market sets, it’s the ‘truest’ (and fairest) rate out there. It’s the rate remittance service providers should give you when you send money to countries beyond the country you are residing.
Different organisations use different data sets to calculate the mid-market rate, so it can vary depending on where you look it up. But it shouldn’t vary very much. So look for places which update it in real time while the trading market is open.
To see the current mid-market rate, and how it’s changed over the last 30 days, check out rate trackers that most remittance service providers freely provide online.
You can also sign up for rate alerts there and have the platforms send you daily updates on the rate, or let you know when it reaches a certain value.
And as the buy and sell rates are based on the constantly changing demand for and supply of a currency, the mid-market rate is constantly changing too.
The mid-market rate is calculated simply by using the median (midpoint) of the bid and ask (offer) rates. So the mid-market rate is the rate between the spread offered by the market makers.
How do I know if the exchange rates banks offer is any good?
To know if the rate your bank has on offer is any good, you can compare it to the ‘mid-market’ rate to work out the percentage mark-up they are adding for their own profit. Here's how you compare:
It is easy enough to find the live market rates for most currency pairings from Google Finance or Yahoo! Finance. Simply find the currency pair that you want to exchange between, which will be expressed something like this: GBP/USD, or USD/EUR.
Why is the bank rate different from what the actual rate is?
The market rate you will find in the step above is not the same as the rate you can get from walking into the bank. This is because the market deals with huge trades, and offers favourable rates for volume.
The actual rate available to you will depend on the amount you want to exchange, and other factors, like whether you want the money immediately, or can wait.
Pick a rate to compare. Let's say Mr. X is changing dollars to sterling, for a trip from the US to London. The market rate we found is USD/GBP 0.68. However, the rate offered by an online exchange service is USD/GBP 0.65.
The mark-up applied by the online exchange service is the difference between the two rates — but you need to turn this into a percentage to compare it.
The difference between the rates is: 0.68 - 0.65 = 0.03
To turn this into a percentage, divide it by the market exchange rate and multiply by 100: 0.03/0.68 = 0.04411765 (X 100) = 4.41 per cent
This is a real example, and shows the huge mark-up that some online exchange services charge, which is exactly why you need to watch out!
In this case, the service applied a mark-up of 4.4 per cent to allow you to change your cash — a hefty fee. But now that you know the math, you can quickly compare rates — and choose the service that offers the best value.
Knowing that some currency exchange platforms are charging a big fee is one thing. More useful is knowing what to do about it, so you can knock it off the list of things you might be overcharged for on vacation or remittance.
There will be a mark-up on the market rate, but keeping this as low as possible will mean you get more bang for your buck.
Research is key, especially if you have some time to observe the rates and get a grasp for what the market is doing.
Currency converters available online are the best way to keep an eye on the fluctuations in rate. If you have the luxury of time, then you can wait for the rate to improve before making your exchange.
The biggest threat to your hard-earned cash is the fact that many banks and platforms hide fees and charges in small print.
So for example, a bank might claim to charge no commission, but the chances are that they adjust their rate to mean you pay over the odds for the currency.
Or you might find that the package of "premium" perks, like having your cash delivered securely to your home, or being able to sell your spare change back to the bank, turn out to be more expensive than they are worth.
Be really clear on the services you need, and you won't be tricked into thinking a package is a great deal when it is not!
Misleading pricing: You'll see an offer for a '0 per cent fee', 'zero commission' or 'our best rates*’.
A set 'day rate': Most providers take the mid-market rate, and apply a margin on top, without being transparent. So you have no idea how much they're over charging you by.
An unfair deal on your currency: By hiding the real charge in the exchange rate offered, most providers make huge profits at your expense, and you're none the wiser.