What Are Cross Currency Pairs And What Do Currency Swap Mean? | Motilal Oswal
What Are Cross Currency Pairs And What Do Currency Swap Mean? | Motilal Oswal

What Are Cross Currency Pairs And What Do They Mean?

At the end of the second world war, and at the dawn of the process of globalization, there stood a need to value the currencies of countries in a standardised format. As a result, currencies of all countries were valued against the dollar. This was due to the fact that the USA had one of the strongest economies and currencies after the second world war, and their currency was also linked to that of gold, creating what is known as the ‘gold standard’. Each currency, therefore, created a cross currency pair with the dollar.

  • Understanding a currency pair

A currency pair is the result of the process of weighing a country’s currency by putting it in currency pairs with another currency, most likely the dollar. Take the currency pair of the Euro and the US Dollar for instance; this currency pair would be represented as EUR/USD. Here, the former of the currency pair is the base currency, the latter the quote currency. The Euro, therefore, is the base currency, and the dollar the quote. Thus, 1 Euro is worth 1.23 dollars.

  • Cross-currency pairs.

While the second world war established the US dollar as the base currency for all currency pairs, rapid progress in the process of globalisation and digitisation of markets has resulted in the need for currency pairs that do not include the US dollar. This is partly due to the rise of the forex market, where investors and traders are looking to deal in multiple currencies at a rapid pace. Previously, if one wanted to buy and sell currency, their currency would first have to be converted to the US dollar through that currency pair and then to the currency they wish to purchase. This process increased the time and rates offered to investors. A cross-currency pair was thus created.

A cross currency pair is a currency pair that does not include the US dollar, not as the base or the quote currency. This currency pair sees two different currencies being weighed against each other in a cross-currency pair, without having to be weighed against the dollar, making forex trade and conversions exponentially easier. A common cross currency pair is the Euro against the Japanese Yen; EUR/YEN.

The formation of these cross currency pairs allows forex traders and investors to exchange currencies quicker and more efficiently, allowing them to better manoeuvre around the fluctuations in the forex markets. For instance, forex investors could create a cross currency pair of the British Pound and the Euro in order to try and make investments based on Brexit.

Conclusion.

Currency pairs aid in converting currencies especially for online forex trade. While the US dollar was part of all currency pairs due to its gold standard, the abolishment of this standard, in addition to the growth of various other countries into global economies, the need for cross currency pairs arose. Cross-currency pairs allow for seamless conversions of currencies, without having to rely on the US dollar as the reference point.

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