- History of the Forex Markets
- The Development of the Eurodollar Market
- Understanding Spot FX Transactions
- Forex Trading: Reading FX Quotes
- Forex Quotes: Pips and the Big Figure
- Forex: Bid and Offer Rates
- Bid-Offer Spreads and the Market Position
- Forex Rates: Understanding Cross Rates
- Cross Rates and Different Base Currencies
- Common Practices in Foreign Exchange Markets
- Foreign Exchange Market Participants
Cross Rates and Different Base Currencies
If we look at two sets of currency pairs with different base currencies you can still adopt the same procedure to find a cross currency quote, provided that you remember the basics.
For example, suppose cable (GBP/USD) is 1.6175 and USD/CAD 1.3639/42.
We can now find the GBP/CAD cross rate as follows.
GBP will be taken as the base currency for the cross rate quotation
|Bid Price||Market maker buys GBP, sells CADBuy GBP, sell USD at 1.6175Sell CAD, buy USD at 1.3639Bid price = 1.6175 X 1.3639 =2.2061|
|Offer Price||Market maker sells GBP, buys CADSell GBP, buy USD at 1.6178Buy CAD, sell USD at 1.3642Offer price =1.6180 X 1.3642=2.2073|
|Cross rate||GBP/CAD rate is 2.2061-2.2073|
Notice that in this example, since the GBP/USD rate is quoted with GBP as base, we need to multiply rather than divide to arrive at the cross rate.
Rules for Calculating Cross Rates
Other Aspects of Cross Rates
In making the above calculations, we have used two spreads, representing liquidity and volatility risk in two markets. This spread is not necessary if a position can be covered directly in one market. Spreads will be wider for less-actively traded cross currency pairs, because the market maker will split deals into two dollar positions, with equal and opposite notional dollar values, and cover them in the respective markets.
Most interbank FX transactions do not involve cross rates, i.e. do not involve the exchange of two non-dollar currencies. Some cross rates, however are increasingly traded by banks in addition to US dollar-based rates.