How does currencies get their exchange rate?

Answer 1

Supply and demand. It all has to do with the trade balance. If a country exports more than it imports, it is selling more to other countries than it is buying. Thus, other countries need more of its money in order to keep purchasing. This causes demand for the currency to increase, thus pushing up the price of the currency, which is the exchange rate.

If a country buys more than it sells, then it sends out more of its currency than other countries need. Thus, demand for its currency falls, and the price for it also falls.

Answer 2

The first answer sums up exchange rates perfectly in an "other factor being equal" scenario. There are other factors that can impact a currency that cannot be readily explained through numbers. Confidence in a currency could have significant effects. For instance right after 9-11 the value of the dollar decreased. No economic formula could explain this, simply a matter of how speculators viewed the currency. Interest rates can also change the value of currency due to costs associated with borrowing that particular currency. Change in government can also affect the way currency traders view the value of a particular currency.

Whether it is a real need for currency or speculators buying and selling a currency, the exchange rate works much the same way the value of a stock works. More people buying the Pound Sterling would increase the exchange rate, while if people were selling the Euro that exchange rate would go down.