Currency Exchange: Definition, How It Works, and Where to Find It (original) (raw)

What Is a Currency Exchange?

A currency exchange is a licensed business that allows customers to exchange one currency for another. The exchange of physical money (coins and paper bills) is usually done over the counter at a teller station, which can be found in various places such as airports, banks, hotels, and resorts.

Currency exchanges make money by charging a nominal fee and through the bid-ask spread.

Also known as a "bureau de change" or "casa de cambio," a currency exchange should not be confused with the foreign exchange (forex) market, where traders and financial institutions transact currency trades.

Key Takeaways

Currency exchanges are businesses that allow customers to swap one currency for another.
Currency exchanges can be found in physical locations, such as banks and airports, but are increasingly common online.
Currency exchange fees vary so much that credit card fees may be less than the fees paid through adjusted exchange rates.
Currency exchanges make money through fees and the bid-ask spread.
A currency exchange is different from the forex market, where currencies are traded.

How a Currency Exchange Works

Currency exchange businesses—physical, online, and peer-to-peer—allow you to purchase another country's currency with your own country's currency.

For example, if you have U.S. dollars and you want to exchange them for Australian dollars, you would bring your U.S. dollars (or bank card) to the currency exchange store and buy Australian dollars with them.

The amount you can purchase is dependent on the international spot rate, which is a daily value set by a network of banks that trade currencies.

Charge for Service

In addition to a service fee, the currency exchange store will modify the rate by a certain percentage to ensure that it makes a profit on the transaction.

For example, suppose the spot rate for exchanging U.S. dollars for Australian dollars is listed as 1.2500 for the day. This means that for each U.S. dollar spent, you can buy 1.25 Australian dollars if traded at the spot rate.

But the currency exchange store may modify this rate to 1.20, meaning you can buy 1.20 Australian dollars for 1 U.S. dollar. With this hypothetical rate change, their fee would effectively be 5 cents on the dollar.

Because the transaction is not conducted at the spot rate, and depends on the profit that the exchange wants to make, consumers may find that it is less expensive to incur ATM or credit card fees at the foreign destination, rather than use exchange services ahead of time.

Travelers are advised to estimate how much money they will spend on a trip and to compare the amounts saved through typical transactions.

Currency convertibility is essential in a global economy and critical for international commerce and finance. A currency that is inconvertible poses big barriers to trade, foreign investment, and tourism.

Where To Find a Currency Exchange

Currency exchange businesses can be found in a variety of forms and venues. One might be a stand-alone, small business operating out of a single office. Or you might find access to a larger chain of small exchange-service booths at airports. Often, a large international bank will offer currency exchange services at its teller stations.

Airports are common places for currency exchanges because of all the business and tourist travel. They enable travelers to purchase the currency of their travel destination immediately before their departure. Travelers can then change any excess money back to their local currency upon their return.

Because airports are seen as the last port of call, the rates at airport exchanges will, in general, be more expensive than those at a bank in the city of departure.

Importantly, going cashless is becoming more common as some banks offer cards that can load multiple currencies on them with little or no fees.

In addition, offshore ATMs are a viable option for those banking with a global bank. For example, HSBC ATMs are prevalent in Europe, North and Latin America, Asia, the Middle East, and North Africa.

Currency exchange services are also provided by businesses that offer their services online. You may find that currency exchange is one of the services provided by a bank, forex broker, or other financial institution.

When traveling outside of your own country, watch out for country-specific fees. For example, prior to July 2020, Cuba charged tourists a 10% tax when buying Cuban convertible pesos (CUC) with U.S. dollars.

Bid-Ask Spreads in the Retail Forex Market

As mentioned, currency exchanges earn their money in two ways. They charge customers a fee for their services and they take advantage of the bid-ask spread in the currency. The bid price is what the dealer is willing to pay for a currency, while the ask price is the rate at which a dealer will sell the same currency.

For example, Ellen is an American traveler visiting Europe. The cost of purchasing euros at the airport may be quoted as follows:

EUR 1 = USD 1.30 / 1.40

The higher price (USD 1.40) is the cost to buy each euro. Ellen wants to buy EUR 5,000, so she would have to pay the dealer USD 7,000 (1.4 x 5,000).

Suppose also that the next traveler in line has just returned from her European vacation and wants to sell the euros that she has left over. Katelyn has EUR 5,000 to sell. She can sell the euros at the bid price of USD 1.30 (the lower price) and would receive USD 6,500 in exchange for her euros.

Because of the bid-ask spread, the kiosk dealer is able to make a profit of USD 500 from this transaction (the difference between USD 7,000 and USD 6,500).

Just remember, when faced with a standard bid and ask price for a currency, the higher price is what you would pay to buy the currency and the lower price is what you would receive if you were to sell the currency.

Can I Get Foreign Currency at a Bank?

Yes, a bank often can help with that, especially if you're a customer. For instance, at Bank of America, if you have an account, you can order foreign currency online and have it shipped to you the same day.

What Is the Cheapest Way To Buy Foreign Currency?

Check with a local bank or credit union first. They often offer the best rates on currency exchanges. Also, you may be able to use your credit card to get foreign currency from an ATM at your destination without paying foreign transaction fees.

Can I Just Use a Credit Card When I Travel Abroad?

As long as your card is accepted where you travel, yes. You can use your card for your purchases and payments—say, for hotel and restaurants. (Be sure to ask your bank about the fees for using your card abroad). Nevertheless, it might be a good idea to travel with some foreign exchange. So plan ahead.

The Bottom Line

A currency exchange is a business that facilitates the exchange of currencies for its customers. For instance, if you live in the U.S. and are traveling to Europe, you'd most likely want to have euros for your trip. At a currency exchange, you would buy euros with your U.S. dollars.

Currency exchanges provide this service for a fee. They also make money on each transaction through the currency bid-ask spread.