Understanding FX Rates and Markups

Foreign exchange (FX) rates can seem complex, but understanding how they work is essential for businesses making international payments. This guide breaks down everything you need to know about FX rates, markups, and how to calculate the true cost of your transfers.

1. What is an Exchange Rate?

An exchange rate is the price of one currency expressed in terms of another currency. For example, if GBP/EUR = 1.17, it means £1 is worth €1.17.

Types of Exchange Rates:

• Mid-Market Rate: The midpoint between buy and sell prices in the global currency market
• Interbank Rate: The rate banks use when trading with each other
• Retail Rate: The rate offered to consumers and businesses (includes markup)

2. What is FX Markup?

FX markup (also called spread or margin) is the difference between the mid-market rate and the rate you actually receive. This is how payment providers make money on currency exchange.

Example Calculation:

• Mid-market GBP/EUR rate: 1.1700
• Provider's rate: 1.1550
• Difference: 0.0150 (1.28% markup)

3. How Much Markup Should You Expect?

Typical Markup Ranges:

• Traditional Banks: 3-5% markup
• High Street Banks: 2-4% markup
• Specialist Providers: 0.3-1.5% markup
• Top Rated Providers: 0.2-0.8% markup

Impact on £10,000 Transfer:

• 5% markup = £500 in hidden costs
• 2% markup = £200 in hidden costs
• 0.5% markup = £50 in hidden costs

4. Calculating the True Cost

Step-by-Step Example:

Scenario: You need to send £10,000 to a supplier in Europe

Provider A (Traditional Bank):

• Transfer fee: £25
• Mid-market rate: 1.1700
• Bank's rate: 1.1300 (3.4% markup)
• Amount received: €11,300
• Total cost: £25 fee + £342 markup = £367

Provider B (Specialist):

• Transfer fee: £5
• Mid-market rate: 1.1700
• Provider's rate: 1.1650 (0.43% markup)
• Amount received: €11,650
• Total cost: £5 fee + £43 markup = £48

Savings: £319 per transfer by choosing Provider B

5. Factors That Affect Exchange Rates

Market Factors:

• Economic Data: GDP, employment, inflation reports
• Interest Rates: Central bank policy decisions
• Political Events: Elections, policy changes, geopolitical tensions
• Market Sentiment: Investor confidence and risk appetite
• Trade Balance: Import/export levels

Time-Based Factors:

• Time of Day: Rates can vary throughout the trading day
• Day of Week: Weekends typically have wider spreads
• Market Hours: Liquidity is better during overlapping market hours

6. Types of Exchange Rate Products

Spot Transfers:

• Current market rate
• Immediate or T+2 settlement
• Best for: One-off transfers, urgent payments

Forward Contracts:

• Lock in a rate for future date (up to 2 years)
• Protect against adverse rate movements
• Best for: Budgeting, large future payments, regular international contracts

Limit Orders:

• Set your target rate
• Automatically execute when rate is reached
• Best for: Non-urgent transfers, optimizing rates

Market Orders:

• Execute at current best available rate
• Immediate execution
• Best for: Time-sensitive payments

7. Hidden Costs to Watch For

• Intermediary Bank Fees: Additional charges from banks in the transfer chain
• Receiving Bank Fees: Charges deducted by recipient's bank
• Conversion Fees: Separate charges for currency conversion
• Same-Day Fees: Premium for faster processing
• Account Maintenance: Monthly or annual account fees
• Inactivity Fees: Charges if account not used regularly

8. How to Get Better Rates

Negotiation Tactics:

• Volume Discounts: Higher transaction volumes often get better rates
• Regular Business: Consistent usage can unlock preferential pricing
• Larger Transfers: Bigger amounts may qualify for reduced margins
• Account Manager: Request dedicated support for better rates

Timing Strategies:

• Monitor rates and wait for favorable movements
• Use limit orders to capture target rates
• Avoid weekends when spreads widen
• Transfer during peak market hours for better liquidity

9. Comparing Provider Rates

What to Compare:

• Live Rates: Check actual rates at the time you need to send
• Total Cost: Include all fees plus FX markup
• Amount Received: Focus on what arrives, not what you send
• Speed vs Cost: Faster transfers may have higher markups

10. Real-World Example

Case Study: UK Business Paying US Supplier

Monthly Payment: £50,000 to USD supplier

Previous Bank:

• Transfer fee: £40 × 12 = £480
• FX markup: 2.8% = £1,400 monthly = £16,800 annually
• Annual cost: £17,280

New Specialist Provider:

• Transfer fee: £8 × 12 = £96
• FX markup: 0.45% = £225 monthly = £2,700 annually
• Annual cost: £2,796

Annual Savings: £14,484

Key Takeaways

1. Mid-market rate is your reference point - no one offers it exactly
2. FX markup is often more expensive than advertised fees
3. Calculate total cost including all fees and exchange rate difference
4. Compare providers based on amount received, not sent
5. Use forward contracts for budgeting and rate protection
6. Negotiate better rates with regular high-volume transfers
7. Be aware of hidden costs beyond headline fees