EXCHANGE PARITY: CHARACTERISTICS, CALCULATION, EXAMPLE - ECONOMY - 2025

The exchange parity refers to the exchange rate between the currencies of two countries in order to make the purchasing power of both currencies substantially equal. It is also known as currency parity. Therefore, the exchange parity shows the relationship between two currencies, that is, how much of one currency must be delivered to be able to take a unit of another currency.

In theory, currency exchange rates can be set at parity level and gradually adjusted to maintain parity as economic conditions change. Adjustments can be made in the market, changing prices, as supply and demand conditions change.

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This type of adjustment occurs naturally if exchange rates are allowed to fluctuate freely or within wide ranges.

However, if exchange rates stabilize, are arbitrarily set, or are set within a narrow range, interest rates can be maintained through the intervention of national governments or international agencies such as the International Monetary Fund.

characteristics

With the globalization existing in the world, changes in the exchange rate generate important influences on the economy of nations, both in imports, exports, structure of the productive system, inflation, etc.

There are many economic models and investigations to be able to investigate these phenomena.

Floating and fixed parity

When faced with a floating exchange parity exchange policy, the exchange parity may be modified over time, due to various reasons for the supply and demand of currencies. For example, in recent years the value of the euro against the dollar has fluctuated between 1.20 and 1.60.

When it refers to a fixed exchange rate, it means that the value of the currency remains unchanged over time with respect to the value of another currency, another basket of currencies or some other indicator, such as the price of gold.

Currently, neither the European Central Bank, nor the US Federal Reserve, nor the Bank of Japan, nor the Bank of England, intervene in the market to seek an exchange rate.

Most of the monetary policies follow other criteria, such as the reactivation of bank credit or stimuli in times of crisis.

For investors, the exchange rate is only of interest when they want to obtain more reserves of a certain currency without the purpose of carrying out investments quickly.

Interest rates

One of the measures that most affect the value of a currency is changes in interest rates. Commonly, high rates lower inflation and encourage the currency to fare when it crosses other currencies.

However, this can be a burden on exports and does not support an economy with domestic consumption difficulties either.

On the other hand, low rates encourage credit approval with the resulting negative impact on private and public debt. Additionally, it is not very clear that they are fighting deflation.

How is the exchange rate calculated?

First, you need to find the updated conversion rate of the country's currency with respect to euros, dollars or the currency to which you want to convert.

It is required to be aware of the exchange rate, which is the daily dollar price, in order to make any decision that allows the money to be safe.This will allow knowing the real value of the country's currency, how much needs to be delivered in exchange for a dollar or any other foreign currency that is required.

This information can be found on the website of a financial institution in the country.

It is important to calculate the amount of money that you are going to have after having made the currency exchange.

You just have to multiply the amount of money to be exchanged by the conversion rate. The result obtained from this operation will be the amount of money that will be had after the currency exchange.

Example calculation

If “a” is the amount of money held in a currency and “b” is the conversion rate, then “c” will be the amount of money that will be held at the exchange rate. In this way: a * b = c, so a = c / b.

It can be seen with the following example: To be able to convert from dollars to euros, knowing that the exchange parity of a US dollar is equal to 0.7618 euros, then if you have $ 1,500 you will have to multiply $ 1,500 by 0.7618, the result of the operation being 1,142.7 euros.

This will be the amount of money in euros that will be had after the exchange rate has been made.

If the method is carried out in reverse, in case 20,000 Hungarian forints are required and it is known that a US dollar is equal to 226.43 forints, then to find out the amount of US dollars that will be needed, divide 20,000 by the exchange parity of 226.43.

The result of this operation is 88.33, which will be the US dollars that will be required to change.

Conversion tools

To know an exchange rate, you can seek support in the updated conversion instruments that are available on the Internet.

In order to know more exactly the current exchange rates of the currencies that are needed, something that can be done is to contact a government institution. This can provide this type of financial information on the exchange rate of the country that is needed.

Example

If you must grant US $ 1.5 to receive one euro, then the exchange rate between those two currencies will be 1.5.

Argentina maintained a 1-to-1 exchange rate between the dollar and the Argentine peso in the period from 1991 to 2001.

This period was called convertibility, since the Argentine central bank kept in its reserves an amount of dollars equivalent to the amount of pesos that circulated in the market. By means of a law, it was impossible for the Central Bank to misalign itself from this procedure.

Currently there are few nations that have an exchange rate established by law. However, nations like China intercede with force in the money market to adjust the exchange rate to the value they consider beneficial for their own economic policy. This is called dirty float.

Forex Market

It is the international currency exchange market. It is made up of an interconnected network of agents. A large number of agents participate in this market, such as institutional investors, individual investors, commercial banks, central banks, etc.

References

1. Encyclopaedia Britannica (2019). Parity. Taken from: britannica.com.
2. Economic Zone (2019). Monetary parity. Taken from: zonaeconomica.com.
3. Business and Economy (2019). The exchange parity. Taken from: Empresayeconomia.republica.com.
4. SAT Guide (2019). Three different methods to calculate the exchange rate easily. Taken from: satgobmx.com.
5. Will Kenton (2019). Parity. Investopedia. Taken from: investopedia.com.