What is Exchange Rate?
An exchange rate is the price at which one currency is converted into another. It can be determined by free-floating markets, managed floats, or fixed pegs by central banks. Exchange rates drive the cost of imports and exports, the value of foreign currency assets and liabilities, and the translation of foreign-currency financial statements under IAS 21.
How It Works
- Spot rate: the rate for immediate exchange of currencies.
- Forward rate: contracted rate for future exchange.
- Bid-ask spread: difference between buying and selling rates quoted by dealers.
- Direct quote: domestic currency per unit of foreign currency.
- Indirect quote: foreign currency per unit of domestic currency.
Saudi Context
The Saudi Riyal (SAR) has been pegged to the US Dollar since 1986 at SAR 3.75 per USD, with SAMA defending the peg through reserves and policy alignment with the US Federal Reserve. Saudi businesses face FX exposure mainly versus EUR, GBP, JPY, INR, and CNY for imports, requiring hedging discipline despite the USD stability.
Example
A Saudi importer agrees to pay EUR 200,000 in 90 days. The current spot rate is EUR/SAR 4.10, but a 90-day forward locks in 4.13. Settlement at the forward rate means SAR 826,000. Without hedging, if the spot rate moves to 4.25, the importer would pay SAR 850,000 instead.