Cross Currency

What is a 'Cross Currency'

A cross currency transaction is one that consists of a pair of currencies traded in forex that does not include the U.S. dollar. One foreign currency is traded for another without having first to exchange the currencies into American dollars.

Common cross currency pairs involve the euro and the Japanese yen. 

BREAKING DOWN 'Cross Currency'

At the end of WW2, most currencies were pegged and quoted against the U.S. dollar, which was fixed to gold. This set precedents when converting two currencies that weren't U.S. dollars.  

Historically, an individual who wished to exchange a sum of money into a different currency would be required first to convert that money into U.S dollars, and then convert it into the desired currency; cross currencies help individuals and traders bypass this step. The GBP/JPY cross, for example, was invented to help individuals in England and Japan who wanted to convert their money directly without having to first convert it into U.S dollars.

However, since the end of the gold standard and the increase of global trading at a wholesale level, cross currency transactions are part of every day financial transacting. Not only do cross currency transactions make it easier for international payments, but they have also made them markedly cheaper. Because an individual does not have to swap the currency into U.S. dollars first, there is only one transaction, meaning only one spread is crossed. Furthermore, because non-USD pairs are now more commonly traded, the spreads have tightened making it even cheaper. 

Common cross currency rates involve the Japanese yen. Many traders take advantage of the "carry trade" where they own a high yielding currency like the Australian dollar or the New Zealand dollar and short the Japanese yen - the low yielding currency.

For trade purposes the EUR/GBP and EUR/CHF are common cross currency pairs.