How do you calculate an exchange rate?

Whether you work for an exporting or importing company, or are a cross-border worker, exchange rates have a significant impact on the funds you receive or pay out. So how do you calculate the exchange rate? Xavier de Villoutreys, Deputy CEO of b-sharpe, answers this question in a video to help you optimise your cash flow management.

The foreign exchange market is what is known as an ‘over-the-counter’ (OTC) market. In practical terms, this means that the price is neither fixed nor official. On the contrary, the exchange rate fluctuates constantly in response to the actions of market participants.

Consequently, the Swiss franc–euro exchange rate offered by banks or other providers (currency exchange bureaux and online currency exchange services) is set at their discretion. The rate offered depends, in particular, on the margins applied, which are themselves influenced by a number of factors.

For example, these margins will naturally be higher at an international bank (mainly due to structural costs) than at a fully digital online currency exchange service such as b-sharpe.

Foreign exchange market: how do financial intermediaries earn their income?

In the foreign exchange market, the trader’s profit comes from the difference between the rate they offer you and the rate at which they themselves will hedge. 

Let’s take the example of a customer who wants to sell 30,000 Swiss francs to get euros in return:

• you deposit CHF 30,000 with the financial intermediary;

• this one offers an exchange rate of 1.12 (in other words, 1 euro is worth 1.12 Swiss francs);

• You will therefore receive €26,785.71;

• the broker sells the 30,000 CHF at 1.11 (1 euro is now worth only 1.11 Swiss francs);

• because it therefore takes more euros to buy the same 30,000 CHF, the intermediary ultimately receives 27,027.02 €;

• By simple subtraction, the broker’s commission will therefore be 26,785.71 – 27,027.02 = €241.31.

It therefore stands to reason that the more favourable the exchange rate offered by the financial intermediary is to its customers, the lower the margin charged will be.
Conversely, as a customer, it is important to ensure that the rates charged by your provider (bank, bureau de change, online currency exchange service) are sufficiently close to those prevailing in the market! To do this, using a currency converter such as b-sharpe’s is highly recommended…

Spread and interbank rate: definitions

The second thing to know is that an exchange rate is divided into two parts:

• the sales rate;
• the purchase rate.

The difference between the two is called the spread. For example, when you are told that the EUR/USD pair is at 1.1430, this is actually the average of the interbank bid rate and the interbank ask rate.

A quick note: the interbank rate refers to the rate at which major banks trade with one another. For them, the spread is negligible (no more than 2 points on the main currency pairs). Conversely, the longer the chain of financial intermediaries, the higher the spread will be for the end customer. The spread is also higher when small amounts are traded.

How is an exchange rate calculated?

The method used to calculate the price quoted to you is always the same: the bank adds a margin (expressed as a percentage) to the relevant interbank rate. Typically, a Swiss bank applies a margin of 1.50% (for amounts under CHF 50,000).

If the EUR/CHF interbank rate is 1.11, the Swiss bank will therefore sell you euros at 1.11 × 1.015 = 1.1266. As for the CHF, these will be sold at 1.11 ÷ 1.015 = 1.0935.

Good to know: Because its structure differs from that of a bank, an online currency exchange service can offer a much lower margin. b-sharpe, for example, offers a margin of just 0.50% of the interbank rate.

In summary, a traditional bank will give you €8,876 for 10,000 Swiss francs exchanged. With b-sharpe, for the same amount exchanged, you will receive €8,964; a profit of €88.

You now understand how exchange rates are calculated. To put this knowledge into practice and optimise your management of currency risk, here are 5 mistakes to avoid the next time you want to exchange your Swiss francs for euros!