What is a Cross-Currency Transaction?
A cross-currency transaction may be used as an arbitrage strategy that involves the simultaneous buying and selling of two or more currencies. This is designed to exploit the differences between currency pairs. This is also called cross-currency triangulation. This action may be advantageous for some market participants based on special conditions and locale. The term is also a generic term for any transaction that involves more than one currency, such as a currency swap.
- Cross-currency transactions can be an institutional arbitrage play.
- Also known as triangulation, this strategy would have the potential for risk-free gains less commission.
- Computerized algorithms are on constant lookout for such a trading opportunity.
How a Cross-Currency Transaction Works
Cross-currency transactions, including cross-currency swaps, are most common for multinational corporations or international bond funds that manage or hedge their currency exposure. Sometimes all the transactions are effected in one country without the use of that country's currency, which is referred to as a currency cross.
As an arbitrage trade, the opportunity to do this is extremely rare for retail traders. For example, if a trader buys Canadian dollars with U.S. dollars (buys a USD/CAD position) and then sells them to buy euros (buys a EUR/USD position), the trader now has effectively the same trade as a EUR/CAD position, and can close it by selling the EUR/CAD pair. This would be worth doing if the EUR/CAD pair were not priced the same as a combined USD/CAD and EUR/CAD pair. Retail traders are unlikely to find these discrepancies because computerized trading algorithms are on constant lookout for such opportunities.