What is Cross Rates?
A cross rates of exchange is an exchange rate between two currencies which is calculated using a third common currency. This third currency is usually USD.
In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency. For example, an interbank exchange rate of 114 Japanese yen to the United States dollar means that ¥114 will be exchanged for US$1 or that US$1 will be exchanged for ¥114. In this case it is said that the price of a dollar in relation to yen is ¥114, or equivalently that the price of a yen in relation to dollars is $1/114.
Each country determines the exchange rate regime that will apply to its currency. For example, a currency may be floating, pegged (fixed), or a hybrid. Governments can impose certain limits and controls on exchange rates.
In floating exchange rate regimes, exchange rates are determined in the foreign exchange market, which is open to a wide range of different types of buyers and sellers, and where currency trading is continuous: 24 hours a day except weekends (i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday). The spot exchange rate is the current exchange rate, while the forward exchange rate is an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
Practice Questions
1. What is a cross rate in foreign exchange?
A) The exchange rate between two currencies that are not the primary currencies in a currency pair
B) The exchange rate between the primary currency and the counter currency in a currency pair
C) The exchange rate between two currencies that are both primary currencies in different currency pairs
2. Why are cross rates important in foreign exchange?
A) They allow for direct exchange between two currencies without having to go through the primary currencies
B) They provide a benchmark for the value of a currency
C) They are used to calculate the bid-offer spread
3. Which of the following is an example of a cross rate?
A) USD/JPY
B) EUR/USD
C) GBP/AUD
4. How is a cross rate calculated?
A) By multiplying the primary currency of one currency pair by the primary currency of another currency pair
B) By dividing the primary currency of one currency pair by the primary currency of another currency pair
C) By subtracting the bid rate of one currency pair from the offer rate of another currency pair
Answers:
1. A
2. A
3. C
4. B
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