Legal Definitions - cross-rate

Cross-rate

A cross-rate refers to the exchange rate between two currencies that is calculated indirectly, using a third, common currency as an intermediary. Instead of directly exchanging Currency A for Currency B, the cross-rate is determined by first converting Currency A into a widely traded third currency (most often the U.S. Dollar), and then converting that third currency into Currency B. This method is often used when a direct exchange market between the two desired currencies is less liquid, less efficient, or simply not available.

Here are some examples:

• Example 1: International Travel

  Imagine a tourist from Japan visiting the United Kingdom. They have Japanese Yen (JPY) and want to exchange it for British Pounds (GBP). While some currency exchanges might offer a direct JPY to GBP rate, it might not be the most favorable or readily available. Instead, the tourist could first convert their JPY into U.S. Dollars (USD) at one rate, and then convert those USD into GBP at another rate. The resulting effective exchange rate between JPY and GBP, derived through the USD, is a cross-rate.

• Example 2: Business Transactions

  A Canadian company needs to pay a supplier in Switzerland, so they require Swiss Francs (CHF). The company primarily holds funds in Canadian Dollars (CAD). Rather than seeking a direct CAD to CHF exchange, which might have higher transaction costs or less competitive rates, the company's bank might first convert the CAD into U.S. Dollars (USD), and then convert the USD into CHF. The exchange rate between CAD and CHF, calculated using the USD as the intermediate currency, is a cross-rate.

• Example 3: Investment Analysis

  An investor is comparing the value of an asset denominated in Australian Dollars (AUD) with another asset priced in South African Rand (ZAR). To accurately compare their relative values, the investor needs to know the AUD/ZAR exchange rate. If a direct market for AUD to ZAR is not very active, they might look up the AUD to USD exchange rate and the ZAR to USD exchange rate. By using the U.S. Dollar as the common reference point, they can calculate the implied AUD to ZAR cross-rate, allowing for a consistent comparison of the two assets.