What is a Foreign Currency Cross-Rate?
A foreign currency cross-rate is a method of determining the exchange rate between two currencies in the absence of a direct exchange rate. This calculation typically employs a widely accepted ‘vehicle currency,’ most commonly the US dollar, as an intermediary. Essentially, if an investor or trader wants to convert between two less-common currencies, they would use the exchange rates of these currencies relative to a vehicle currency to determine the direct exchange rate.
For example, to calculate the exchange rate between the Barbados dollar (BBD) and the Argentine peso (ARS), you would first convert BBD to USD and then USD to ARS. The formula for this cross-rate would be: \[ \text{Cross-Rate} = \frac{\text{USD/ARS Rate}}{\text{USD/BBD Rate}} \]
Examples
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Calculating BBD/ARS Rate:
- Assume the exchange rates are:
- USD/ARS = 100
- USD/BBD = 2
- Cross-Rate (BBD/ARS) = 100 / 2 = 50
- Therefore, one Argentine peso is equivalent to 50 Barbadian dollars.
- Assume the exchange rates are:
-
Calculating EUR/JPY Rate:
- Assume the exchange rates are:
- USD/EUR = 0.85
- USD/JPY = 110
- Cross-Rate (EUR/JPY) = 110 / 0.85 ≈ 129.41
- Therefore, one Euro is approximately equivalent to 129.41 Japanese Yen.
- Assume the exchange rates are:
Frequently Asked Questions (FAQ)
What is meant by a vehicle currency?
A vehicle currency is an intermediary currency used to bridge the exchange rates between two lesser-traded currencies. The US dollar is most commonly used as a vehicle currency due to its strong global presence and liquidity.
Can cross-rates be calculated without a vehicle currency?
Technically, yes, but it would be less common and less efficient. Financial markets typically have liquidity and pricing readily available in major currencies like USD, making them ideal for these calculations.
Why is the US Dollar predominantly used as a vehicle currency?
The US Dollar has a dominant position in global trade and finance, providing high liquidity and stability, which makes it a convenient and reliable medium for foreign exchange calculations.
Do cross-rates fluctuate frequently?
Yes, cross-rates can fluctuate frequently due to changes in supply and demand, economic indicators, geopolitical events, and market sentiment impacting the currency exchange markets.
Are cross-rates important for international businesses?
Absolutely! Cross-rates are vital for companies operating in multiple countries as they affect financial planning, pricing strategies, budgeting, and risk management.
How accurate are cross-rate computations?
Cross-rate computations are generally accurate as they rely on the most current exchange rates available in the Forex market. However, slight variations can occur due to market volatility and the timing of rate updates.
Do all countries agree on using the same vehicle currency?
While the US Dollar is the most commonly used vehicle currency, some currency pairs may use other widely traded currencies like the Euro or the Japanese Yen, depending on regional practices and agreements.
Can individuals use cross-rates for personal transactions?
Individuals can use cross-rates for personal financial planning, travel expenses, or international investments, provided they access reliable exchange rate information.
How are cross-rates displayed in financial reports?
Cross-rates in financial reports are usually displayed with the base currency first (the currency being compared) and with the equivalent amount in the quote currency following after. For example, if calculating EUR/JPY, the cross-rate might be shown as 1 EUR = 129.41 JPY.
Are cross-rates legally regulated?
Foreign exchange markets across the world are subject to international and local regulations to ensure transparency, fairness, and legal compliance in currency trading activities.
Related Terms
- Exchange Rate: The value of one currency for the purpose of conversion to another.
- Vehicle Currency: An intermediary currency used in calculating exchange rates between two other currencies.
- US Dollar (USD): The official currency of the United States, commonly used as a vehicle currency.
- Forex Trading: The act of buying and selling currencies to profit from exchange rate differences.
- Currency Conversion: The process of changing one currency into another.
Online References
Suggested Books for Further Studies
- Foreign Exchange: A Practical Guide to the FX Markets by Tim Weithers
- Trading and Pricing Financial Derivatives: A Guide to Futures, Options, and Swaps by Patrick Boyle and Jesse McDougall
- Currencies: The Ultimate Guide to the Foreign Exchange Market by David Earnshaw
- Currency Trading for Dummies by Brian Dolan and Kathleen Brooks
Accounting Basics: “Foreign Currency Cross-Rate” Fundamentals Quiz
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