What Is a Reciprocal Currency?
In the foreign exchange (forex) market, a reciprocal currency describes a situation where a currency pair involves the U.S. dollar (USD), but the USD is not the base currency; instead, it is the quote currency (also known as the counter currency).
A reciprocal currency is thus quoted in terms of U.S. dollars per unit of foreign currency instead of units of currency per dollar. A common example would be the EUR/USD currency pairs, where a quote of 1.20 would mean that one euro buys $1.20 U.S. dollars.
- A reciprocal currency is a currency pair that involves the U.S. dollar (USD) without the USD serving as the base currency.
- This quote notation is less common than when the USD serves as the base currency and is sometimes called a "European" quotation.
- USD/JPY and USD/CAD are examples where the U.S. dollar is the base currency.
- NZD/USD and EUR/USD are examples of reciprocal currency pairs as the USD is not the base currency in these pairs.
- Exchange rates can be inverted by dividing 1 by the current exchange rate.
Understanding Reciprocal Currencies
The majority of USD currency pairs feature the U.S. dollar as the base currency, which appears first in an FX quote. For example, the USD/JPY (dollar versus the Japanese yen) or the USD/CAD (dollar versus the Canadian dollar).
In such a quote, it would tell you how many units of a foreign currency one U.S. dollar could buy. For instance, if the quote for Israeli Shekels (USD/ILS) is 3.25, one dollar buys 3.25 shekels.
However, reciprocal currencies are instead quoted in what's commonly referred to as "European" terms, meaning the currency other than the U.S. dollar is the base currency.
"Reciprocal currency" thus describes currency pairs used in the foreign exchange market where the U.S. dollar (USD) and another currency are paired, but the USD is not the first currency quoted.
Major currency pairs that involve the USD, but where the USD is not the base currency, include EUR/USD (euro to U.S. dollar); GBP/USD (British pound to U.S. dollar); and AUD/USD (Australian dollar to U.S. dollar).
Example of Reciprocal Currency
An example of a reciprocal currency would be the quotes for the NZD/USD. This currency pair has the New Zealand dollar as its base currency and the U.S. dollar as its quote currency.
In other words, one would quote the exchange rate of NZD/USD as the New Zealand dollar versus the U.S. dollar. So if the NZD/USD quote is 0.70, it means that you can exchange one NZD for seventy cents, U.S.
The topmost traded currencies in the world are the U.S. dollar, euro, Japanese yen, pound sterling, and Australian dollar.
The EUR/USD exchange rate is also expressed in dollar terms, even though the euro is listed as the base currency. For example, the EUR/USD rate might be $1.15 to 1 euro, but when quoting the rate, a trader would say the euro/U.S. rate is $1.15.
What Is a Reciprocal Currency Arrangement?
A reciprocal currency arrangement is an agreement between two nations to maintain a specific money supply of each other's currencies. This improves liquidity between the nations and in the global financial markets, allows for more efficient financial transactions, maintains reserve requirements, and sets exchange rates. Reciprocal currency arrangements are also known as swap lines.
What Is a Currency Pair?
A currency pair quotes the value of two currencies with the value of one currency being quoted against the value of the other. The first currency in the pair is the base currency and the second listed currency is the quoted currency. Currency pairs reveal how much of the quote currency is needed to buy one unit of the base currency.
How Do You Find the Reciprocal Exchange Rate?
A reciprocal exchange rate would be the inverse of the exchange rate. You would divide 1 by the current exchange rate of the two currencies for the inverse relationship. So for example, if the USD/EUR exchange rate was 0.89, to find the reciprocal exchange rate of EUR/USD, you would perform the following calculation: 1/0.89 to arrive at 1.12.
What Are the Two Ways to Quote a Currency?
Currencies can be quoted as direct quotations or indirect quotations. A direct quotation is when one unit of a foreign currency is quoted in the corresponding units of the domestic currency. An indirect quotation is when one unit of a domestic currency is quoted in terms of the equivalent foreign currency.
How Are Foreign Currency Options Quoted?
Foreign exchange options are priced as the intrinsic value + the time value. This is the FX option premium. The intrinsic value is the difference between the converted currencies utilizing the strike rate and forward rate.
The Bottom Line
A reciprocal currency in foreign exchange trading is a currency pair where the USD is not the base currency but rather the counter currency. It is quoted in terms of U.S. dollars per unit of foreign currency. Reciprocal currencies are a large part of FX trading globally, with common reciprocal currencies being EUR/USD, GBP/USD, and AUD/USD.