Currency Exchange: Definition, How It Works, and Where to Find It

What Is a Currency Exchange?

A currency exchange is a licensed business that allows customers to exchange one currency for another. Currency 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 in a currency.

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 in currencies.

How a Currency Exchange Works

Currency exchange businesses—physical, online, and peer-to-peer—allow you to exchange one country's currency for another by executing buy and sell transactions. 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 would be able to purchase would be dependent on the international spot rate, which is basically a daily changing value set by a network of banks that trade currencies.

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 into 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 compare the amounts saved through typical transactions.

Where to Find a Currency Exchange

Currency exchange businesses can be found in a variety of forms and venues. It may be a stand-alone, small business operating out of a single office, a larger chain of small exchange-service booths at airports, or a large international bank offering currency exchange services at its teller stations.

Airports are commonplace for currency exchanges, enabling travelers to purchase currency of their travel destination immediately before their departure or exchange 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.

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 can also be found through businesses that offer these services online. This may be offered as part of the services provided by a bank, forex broker, or other financial institution.

Bid-Ask Spreads in the Retail Forex Market

Currency exchanges earn their money by charging customers a fee for their services, but also by taking 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.

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).

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.