CrossCurrency

Crosscurrency refers to the exchange rate between two currencies that does not involve the US dollar as the base or counter currency. In practice, cross rates are often derived from two USD-denominated quotes and represent the value of one currency in terms of another without directly involving the dollar.

For example, to obtain the EUR/GBP cross rate, one can divide the EUR/USD quote by the GBP/USD quote. Common cross-currency pairs include EUR/GBP, EUR/JPY, GBP/JPY, and AUD/CHF. While USD-quoted pairs remain highly liquid, cross rates among major currencies are typically actively traded and quoted in markets that handle global financing and trade.

Cross-currency instruments include cross-currency swaps, which exchange principal and interest payments in one currency for another. These instruments are used by corporations and financial institutions to manage funding costs, currency exposure, and interest-rate risk across borders. The cross-currency basis refers to the spread that can arise between cross-currency swap rates and related USD-denominated benchmarks, reflecting relative funding conditions.

Applications of crosscurrency rates include pricing multinational transactions, hedging currency risk in international trade and investments, informing relative value analysis, and serving as benchmarks for derivative contracts. They also enable traders to express views on the relative strength of currencies independently of the US dollar.

Limitations and risks involve liquidity differences across currencies, funding costs, and arbitrage frictions. During periods of market stress, cross rates can widen or become less reliable as funding conditions change.

See also: foreign exchange market, currency pair, cross-currency swap, basis.