Cross Rates Explained

Another concept that you might hear mentioned with regard to foreign exchange is the cross rate.

This might seem like it refers to how quickly someone gets angry, but in fact it is a measure of the relative exchange rate between two different currencies, given their exchange rate against a common currency, for instance the dollar.

For instance if you have the pound to dollar rate and the euro to dollar rate then you can work out the pound to euro rate.

So to calculate this if we know the following:
Dollar/Pound 1.9
Dollar/Euro 1.4

This indicates that $1.90 buys £1 and $1.40 Buys E1.

So we can work out the exchange rate as saying that £1 will buy (1.9 / 1.4) Euros which is 1.36, so the Euro/Pound exchange rate will be 1.36.

Of course if there is a spread involved in the price rates then the calculation gets more complicated, but this shows in essence how it all works out.

Now a spread in the initial rates implies a spread in the cross rates and indeed that's what you see, so depending how wide the initial spread is the resultant cross spread will be wide too.

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