Cross-Currency Transaction

A cross-currency transaction is an arbitrage move 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.

For example, a trader buys Canadian dollars with U.S. dollars and then sells them to buy Brazilian reals. He or she does this when the direct exchange rate between U.S. dollars and Brazilian reals is not as favorable.

The term is also a generic term for any transaction that involves more than one currency, such as a currency swap.

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.

The following is excerpted from Investopedia's primer on Cross-Currency Triangulation.

The major significance and importance of cross-currency triangulation is due to the fact that many spot currency cross pairs are not traded against each other in the interbank market as standard pairs. With a realignment of the currency markets due to the adoption of the euro, cross-currency pairs such as the EUR/JPY, GBP/CHF, GBP/JPY, and EUR/GBP, as well as many other cross currency pairs, developed over time, for many reasons. Major companies, importers and exporters, governments, investors and tourists, all needed a method to simultaneously transact business in euros, while allowing for money and profits to repatriate back to their home currencies.

Before triangulation existed, a company in the U.K., selling in Switzerland and receiving Swiss francs, had to sell Swiss francs for U.S. dollars and then sell U.S. dollars for British pounds. Before cross currencies existed, repatriations occurred by triangulating pairs with U.S. dollars. Therefore, triangulation with crosses gave us a means to take advantage of bid-ask spreads in the interbank market.

In most instances, triangulation involves profiting from exchange rate disparities. This can be accomplished in many ways, for example, suppose you institute two buys on a certain pair and one sell, or you sell two pairs and buy one pair. Any number of triangulation opportunities exist every day from banks in Tokyo, London, New York, Singapore, Australia and all the paces in between. Yet, these same opportunities may exist around the world, trading the exact same pair. The most popular triangular opportunities are usually found with the CHF, EUR, GBP, JPY and U.S. dollars, in order to convert from euros to home currencies. (To learn more, read Forex Currencies: Currency Cross Rates.)

The basic formula always works like this: A/B x B/C = C/B. The cross rate should equal the ratio of the two corresponding pairs, therefore, EUR/GBP = EUR/USD divided by GBP/US, just like GBP/CHF = GBP/USD x USD/CHF.