Suppose you're due to receive €100. At $1.10 per euro, it's worth $110. Before it arrives, the rate falls to $1.00 per euro. You still collect €100, but it is worth only $100.
Where did the $10 go?
Nobody paid you fewer euros. Each euro buys fewer dollars. That's the dollar strengthening against the euro. For someone paying a €100 bill from dollars, the same move saves $10.
Read the units before the direction
An exchange rate is the price of one currency in another. At $1.10 per €1, one euro buys one dollar and ten cents. The units tell you which way the conversion runs.
With no conversion fees, €100 × $1.10 per euro = $110; at $1.00 per euro, it becomes $100.
A currency's gain against another is currency appreciation; its loss is currency depreciation. Here the dollar appreciates and the euro depreciates.
To reverse the quote, divide 1 by the rate. At $1.10 per euro, $1 buys about €0.9091 (1 ÷ 1.10). At $1.00 per euro, it buys €1. These opposite quotes are reciprocals.
The euro's dollar price falls about 9.09%: $0.10 ÷ $1.10 × 100. But $110 goes from buying €100 to buying €110, a 10% increase in euros bought. Different starting points give different percentage changes.
What the dollar index leaves out
A currency basket groups currencies and gives each a weight: how much influence it has on the result. A dollar index combines their exchange rates into one measure of the dollar's value against that group.
ICE's US Dollar Index, known as DXY, uses six currencies. The euro fills more than half the bar, with 57.6% of the weight. The yen, pound, Canadian dollar, Swedish krona and Swiss franc share the remaining 42.4%.
DXY leaves out China's renminbi and Mexico's peso, among others. A dollar headline based on DXY tells you nothing certain about either exchange rate.
The Fed's broad trade-weighted dollar index covers a wider set of trading partners. Its weights reflect US trade in goods and services with each partner and are updated annually. That makes it a broader lens on the dollar's effects on US trade.
Even within a basket, currencies need not move together. An index can rise while the dollar falls against one of its currencies. For a business collecting euros, dollars per euro still matters more than the index headline.
Why currencies move
If expected US interest rates rise relative to euro-area rates, dollar deposits and bonds can become more attractive. Buying dollars to fund those investments increases demand for the currency.
As with stocks, compare a rate move with expectations. For currencies, compare both countries' expected rate paths, not just the US decision.
Inflation, growth prospects and willingness to take risk also influence currency demand. During financial stress, demand for dollar assets seen as safe and easy to sell can support the dollar. These forces can pull in different directions.
A higher rate is a clue, not a currency forecast.
Follow receipts and bills
Replace the opening receipt with a €100 bill. The conversion is identical:
| Item | At $1.10/€ | At $1.00/€ |
|---|---|---|
| €100 receipt | $110 | $100 |
| €100 bill | $110 | $100 |
A weaker euro means fewer dollars coming in and fewer dollars going out. The receipt loses $10 of dollar value; the bill gets $10 cheaper.
Currency translation means expressing foreign amounts in a company's reporting currency. A US company can report a lower dollar value for a foreign business that keeps its accounts in euros, even if no cash moves. That reporting risk is translation exposure.
Transaction exposure is the risk that an agreed foreign-currency receipt or payment changes in dollar value before it is settled. The opening €100 receipt has this exposure: convert the euros when they arrive and you collect $10 less.
Matching receipts and payments can offset that risk. If a business receives €100 and owes €100 at the same time, the receipt covers the bill without conversion. Hedges, arrangements designed to reduce currency risk, can also offset exposure.
For a US multinational, follow the currencies it earns and spends. Its stock's listing location does not reveal those amounts. Lower dollar revenue alone cannot tell you what happened to profit; costs, contracts and hedges matter too.
Sales at constant currency
A constant-currency comparison recalculates results using the same exchange rates across the periods being compared. It helps separate a change in sales from a change in the measuring stick.
Say a business makes €100 of sales in each of two years. Use $1.10 per euro for the first year and $1.00 for the second. Reported dollar sales fall from $110 to $100. Recalculate both years at $1.10 and each shows $110: zero growth at constant currency.
Companies use different methods, so read their definitions. The comparison explains the sales trend; it does not recover the missing $10 if the euros are exchanged at the lower rate.
Two prices in one holding
For a foreign holding, the asset price and exchange rate work together. Over a year, let its price rise 10%, from €100 to €110, while the quote falls from $1.10 to $1.00 per euro.
It starts at €100 × $1.10 = $110 and ends at €110 × $1.00 = $110. Its dollar value is flat before distributions. A gain in euros can disappear when measured in dollars.
The same conversion reaches oil and other commodities. At $1.10 per euro, a fixed $110 commodity bill costs €100 ($110 ÷ 1.10). At $1.00 per euro, it costs €110. An unchanged dollar price can still mean a bigger bill in euros.
In short
- An exchange rate is a price with two currencies; the units tell you how to convert it.
- A stronger dollar buys more of the named foreign currency.
- DXY gives the euro more than half its weight and leaves many currencies out.
- A weaker euro shrinks both a euro receipt and a euro bill when measured in dollars.
- A currency hit to sales is only part of the profit story: costs, contracts and hedges matter too.