Definition
A cross rate is the exchange rate between two different currencies, determined by their exchange rates against a common third currency, typically the US dollar. In foreign exchange (forex) markets, the cross rate helps in comparing currencies without using the US dollar as the intermediary.
Examples
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EUR/JPY Cross Rate: If the exchange rate of the Euro (EUR) to US Dollar (USD) is 1.20, and the exchange rate of Japanese Yen (JPY) to US Dollar (USD) is 110, the EUR/JPY cross rate can be computed as follows:
\[ \text{EUR/JPY} = \frac{1.20}{110} = 132.00 \] This means one Euro is equivalent to 132 Japanese Yen. -
GBP/CAD Cross Rate: If the exchange rate of the British Pound (GBP) to US Dollar (USD) is 1.30, and the exchange rate of Canadian Dollar (CAD) to US Dollar (USD) is 0.75, the GBP/CAD cross rate can be determined:
\[ \text{GBP/CAD} = \frac{1.30}{0.75} = 1.7333 \] This indicates one British Pound equals 1.7333 Canadian Dollars.
Frequently Asked Questions
What is the significance of cross rates in forex trading?
Cross rates are significant because they allow traders and investors to analyze and trade currency pairs directly, without converting to the US dollar. This can help avoid additional transaction costs and potentially take advantage of arbitrage opportunities.
How is a cross rate calculated?
A cross rate is calculated by dividing the exchange rate of one currency against the US dollar by the exchange rate of another currency against the US dollar. Essentially, it involves the ratio of the two rates.
Why are most cross rates derived using the US dollar?
The US dollar is often used as an intermediary because it is the most widely traded and held currency globally. This extensive use provides a standard measure for comparing two other currencies.
Can cross rates exist between any two currencies?
Yes, cross rates can exist between any two currencies; however, they are most commonly calculated for currencies not normally quoted directly against each other in forex markets.
How do cross rates benefit businesses?
Cross rates help businesses in international trade to accurately convert currencies for pricing, accounting, and hedging purposes, ensuring that they minimize exposure to currency risk.
Related Terms with Definitions
- Exchange Rate: The price at which one currency can be exchanged for another.
- Forex (Foreign Exchange Market): A global marketplace for exchanging national currencies against one another.
- Arbitrage: The simultaneous purchase and sale of an asset to profit from an imbalance in the price.
- Currency Pair: The quoting of two different currencies, where the value of one is quoted against the other.
- USD (United States Dollar): The official currency of the United States, commonly used as a reference or intermediary currency in cross rate calculations.
Online Resources
Suggested Books for Further Studies
- “Currency Trading for Dummies” by Kathleen Brooks and Brian Dolan.
- “Foreign Exchange: A Practical Guide to the FX Markets” by Tim Weithers.
- “A Beginner’s Guide to Forex Trading” by Matthew Driver.
Accounting Basics: “Cross Rate” Fundamentals Quiz
Thank you for deepening your understanding of cross rates through our detailed explanation and tackling these enlightening quiz questions to further your financial knowledge!
