crossrate

A cross rate is a currency exchange rate between two currencies that do not involve the U.S. dollar as the base reference. In practice, cross rates are calculated from pairs that each have a common reference currency, often the U.S. dollar, but they can also be built from other reference currencies. Cross rates allow traders to quote and trade currencies directly against each other even when there is no direct market quote between them.

Construction and calculation example: If EUR/USD is 1.15 and GBP/USD is 1.32, the cross rate for EUR/GBP is obtained by dividing the two: EUR/GBP = (EUR/USD) / (GBP/USD) = 1.15 / 1.32 ≈ 0.871. This means 1 euro costs about 0.871 British pounds. The reciprocal quote, GBP/EUR, would be approximately 1.148 (the inverse). Cross rates can be computed similarly using any common reference currency, and the result is a direct quote between the two non-reference currencies.

Uses and significance: Cross rates are important for pricing, hedging, and settlement in international trade when direct quotes are not readily available. They also aid in price discovery and in maintaining consistency across currency markets. Traders monitor cross rates for arbitrage opportunities and to understand relative currency movements, especially when the dollar’s value, central bank policies, or liquidity conditions shift.

Market dynamics: Cross rates reflect the relative demand and supply for each currency vis-à-vis the common reference and are subject to bid-ask spreads, transaction costs, and prevailing interest rate differentials. Triangular arbitrage tends to keep cross rates consistent with the two constituent pairs, so persistent mispricing is typically temporary.