Exchange rates are the prices at which one currency can be converted into another. They are set by the global foreign exchange (forex) market — the largest, most liquid financial market in the world — and they affect everyone: from multinational corporations and central banks to individuals sending money home to their families.
Not all currencies operate the same way. There are two main types of exchange rate systems:
Most major currencies — the US Dollar (USD), Euro (EUR), British Pound (GBP), Japanese Yen (JPY), Australian Dollar (AUD), and Indian Rupee (INR) — operate under floating exchange rate regimes. Their value is determined by supply and demand in the open market, with central banks occasionally intervening to smooth extreme volatility.
Some currencies are pegged to a major currency, most commonly the US Dollar. The UAE Dirham (AED) is fixed at 3.6725 per USD. The Saudi Riyal (SAR) is fixed at 3.75 per USD. Qatar (QAR) and Bahrain (BHD) also maintain USD pegs. These pegs are maintained using foreign exchange reserves and monetary policy, giving stability to trade and investment in these countries.
The forex market is a decentralised, over-the-counter (OTC) global market where currencies are traded 24 hours a day, five days a week. It is not a single exchange like the stock market — it operates through a network of banks, financial institutions, brokers, and electronic trading platforms spread across the world's major financial centres.
Trading begins each week in Sydney and Tokyo, then moves through Singapore, then the European markets open in London and Frankfurt, and finally the US session begins in New York. As each centre closes, the next one opens, creating a continuous 24-hour market during weekdays. The most active and liquid trading period is the London-New York overlap (approximately 1pm–5pm London time).
Daily forex trading volume exceeds $7.5 trillion — making it roughly 30 times larger than global equity markets combined.
At its simplest, exchange rates are driven by supply and demand for a currency. When more people want to buy a currency (demand increases), its value rises. When more people want to sell (supply increases), its value falls. What drives this demand and supply? Several factors:
In the forex market, every currency pair has two prices: the bid (the price at which a dealer will buy the base currency) and the ask (the price at which they will sell). The difference between these two prices is the spread.
For major pairs like USD/INR, the spread in the interbank market is tiny — fractions of a paisa. However, when you go to a bank or exchange house, they apply a much wider spread to build in their profit. The mid-market rate that you see on Google is the midpoint between bid and ask — and it is this rate that currency converter tools like RateRocket FX display as the reference rate.
Banks and money transfer companies make money on currency exchange in two main ways: (1) the spread between bid and ask rates, and (2) fixed transaction fees. When you use a bank to convert currency, you receive a rate that is worse than the mid-market rate — sometimes by as much as 3–5%. This difference is the bank's profit on the transaction and is rarely made explicit in advertising.
Specialist transfer services like Wise were built specifically to challenge this model by offering rates much closer to the mid-market benchmark with transparent, lower fees.
Disclaimer: This article is for educational purposes. Not financial advice.