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Sunday, March 14, 2010

Base Currency and a Terms Currency

Every foreign exchange transaction involves two currencies—and it is important to keep straight which is the base currency (or quoted, underlying, or fixed currency) and which is the terms currency (or counter currency). A trader always buys or sells a fixed amount of the “base” currency, most often the dollar—and adjusts the amount of the “terms” currency as the exchange rate changes.

The terms currency is thus the numerator and the base currency is the denominator.When the numerator increases, the base currency is strengthening and becoming more expensive; when the numerator decreases, the base currency is weakening and becoming cheaper.

In oral communications, the base currency is always stated first. For example, a quotation for “dollar yen”means the dollar is the base and the denominator, and the yen is the terms currency and the numerator; “dollar-swissie” means that the Swiss franc is the terms currency; and “sterling-dollar” (usually called “cable”) means that the dollar is the terms currency.

Currency codes are also used to denote currency pairs, with the base currency usually presented first, followed by an oblique. Thus “dollar-yen” is USD/JPY; “dollar-Swissie” is USD/CHF; and “sterling-dollar” is GBP/USD.

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