Key Takeaways
- A cross rate involves exchanging two currencies, usually against the U.S. dollar as a reference.
- Cross rates typically don’t include the U.S. dollar, such as the euro versus the Japanese yen.
- Common cross-currency pairs include EUR/GBP and EUR/JPY, actively traded on global markets.
- The U.S. dollar often serves as the benchmark to value the currencies involved in cross rates.
- Minor cross rates like CHF/JPY are less actively traded than major cross rates.
What Is a Cross Rate?
A cross rate is an exchange of any two currencies that aren’t the official currency of the country in which the quote is published. Any currency exchange in which neither of the currencies is the U.S. dollar is considered a cross rate in practice. One of the most common cross-currency pairs is the euro and the Japanese yen. Foreign exchange traders use the term cross rate to refer to price quotes between any pair of currencies that doesn’t include the U.S. dollar.
How Cross Rates Work in Currency Exchange
The U.S. dollar is usually used to establish the value of each of the two currencies being traded. You would first determine that the British pound was valued at maybe 1.25 to one U.S. dollar and that the euro was valued at 1.07 to one U.S. dollar if you were calculating the cross rate of the British pound versus the euro,
Exploring Major Currency Pairs
Foreign exchange (forex) traders use the term cross rate to refer to price quotes between currencies in which neither is the U.S. dollar.
Most transactions on the forex are in major currency pairs. When a financial news site quotes USD/CAD at 1.28, it means one U.S. dollar equals 1.28 Canadian dollars.
Important
A cross rate also refers to a currency pair or transaction that doesn’t involve the currency of the party initiating the transaction.
The exchange rate between the euro and Japanese yen is a common cross rate since it excludes the U.S. dollar. But in the pure sense of the definition, it’s considered a cross rate if it’s referenced by a speaker or writer who isn’t in Japan or one of the countries that use the euro as its official currency.
The true definition of a cross rate involves quoting a rate in a region where neither currency is used, but it’s mostly applied to trades that don’t involve the U.S. dollar.
Key Examples of Major Cross Rates
While any two currencies can be paired, the euro versus the British pound (EUR/GBP) and the euro versus the Japanese yen (EUR/JPY) are among the most traded. These two pairs are the only cross-rate currency pairs that appear in the top 10 most traded currency pairs.
The euro is the base currency for the quote if it’s included in the pair. The British pound is the base if the pound is included but the euro is not.
Notable Examples of Minor Cross Rates
Less active interbank cross rates include the Swiss franc against the Japanese yen (CHF/JPY) and the British pound against the Swiss franc (GBP/CHF). Cross rates involving the Japanese yen are usually quoted as the number of yen versus the other currency regardless of the other currency.
Currencies similar in value and conventions need careful quoting to avoid trading mistakes. The New Zealand dollar (NZD) was quoted at 1.08 per Australian dollar (AUD) in late December of 2023. Both of these currencies are quoted against the U.S. dollar. The value reflects the number of U.S. dollars it would take to buy the foreign currency.
But the quote provides no guidance as to which is the base currency. The market convention is to use the stronger AUD, which is also the larger economy, as the base. The two currencies trade near parity to each other, however, creating the potential for a misquote.
What Is Reciprocal Currency?
Reciprocal currency is a term used in the foreign exchange market to denote a pair of currencies that includes the U.S. dollar. But the U.S. dollar isn’t used as the transaction’s base currency or the currency that’s initially quoted.
What Is the Foreign Exchange?
The foreign exchange is a market in which a foreign currency is traded for a domestic currency. The market deals only in currencies and not in other services or goods.
Does the Value of the U.S. Dollar Change Often?
Currency values aren’t carved in stone. They “float” and can change frequently due to various factors. You can’t buy as much foreign currency with the U.S. dollar when the dollar is weak.
The Bottom Line
Cross rates involve exchanging two currencies, neither of which is the U.S. dollar. Nonetheless, the USD is frequently used as a reference currency for cross rates. The most commonly traded cross-currency pairs include EUR/GBP and EUR/JPY.
The major crosses have bid-offer spreads that are slightly wider than the major dollar-based pairs but they’re quoted actively in the interbank market. Spreads in the minor crosses are generally much wider. Some are not quoted directly at all so a quote must be constructed from the bids and offers in the component currencies versus the U.S. dollar.
