Foreign exchange rates represent the value of one country's currency relative to a different currency. It is therefore also the rate at which one currency can be bought with another currency.
The value of differing currencies derives from the strength of the underlying nation's economy. Factors affecting the health of a nation's economy include inflation, interest rates, trade balance and political stability. Weak economies have adverse effects on the nation's currency. For example, if a country is crippled by high inflation and an unstable government, the value of its currency will weaken relative to other currencies. A weakened currency diminishes the purchasing power of the affected country and its citizens.
Most exchange rates are fixed and tied to a benchmark or base currency, such as the US dollar. However, some currencies utilize a floating exchange rate in which the rate of exchange is elastic under particular market forces.
Exchange rates are vital processing worldwide financial transactions. There is no global or uniform currency, so an institution or individual cannot purchase goods or services in the United States with Japanese Yen, for example. To complete such a transaction, the Yen must be converted under the current foreign exchange rate to US dollars.