What is a Currency Basket
A currency basket is a selected group of currencies in which the weighted average is used as a measure of the value or the amount of an obligation. A currency basket functions as a benchmark for regional currency movements - its composition and weighting depend on its purpose.
Colloquially, a currency basket is often referred to as a currency cocktail.
BREAKING DOWN Currency Basket
A currency basket is commonly used in contracts as a way of avoiding (or minimizing) the risk of currency fluctuations. The European currency unit (which was replaced by the euro) and the Asian currency unit are examples of currency baskets. However, the most well-known currency basket is the U.S. dollar index (USDX).
The U.S. dollar index started in 1973, and today is a basket of six currencies; the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc. The euro is by far the biggest weighting making up 58 percent of the basket. During the 21st century the index has reached a high of 121 during the tech boom and a low of 71 just prior to the Great Recession.
Usage of Currency Baskets
Equity investors who have exposure to different countries will use a currency basket to smooth risk. Because their core investment strategies are in the equity markets, they do not want to report any substantial losses in a market they are not experts in. The same can be said for bondholders.
On the other hand, currency traders who have a broad-based view of a single currency will choose to own that currency against a variety of different currencies. For example, traders that are bullish the U.S. dollar could use the USDX to express this trade. Traders and investors can build their own currency baskets with different weightings depending on their strategy.