Currency pair
Every trade in the foreign exchange market, expressed as one currency bought against another currency sold — the unit in which all currency derivatives are quoted and traded.
In plain language
A stock trade has one thing being priced: the share, against rupees. A currency trade is different. There is no single "currency price" — a currency only has a value when measured against another currency.
A currency pair is that measurement. Buying dollars means selling rupees for them; the trade only makes sense as a pair. This is why the workbook calls the currency pair the single most distinctive part of trading in the currency market, unlike any other traded asset class.
When an adviser talks about a currency derivative, the underlying asset is always this exchange rate between two currencies, not a currency on its own.
How it works
Currency derivatives on Indian exchanges are available on four currency pairs: the US Dollar (USD), the Euro (EUR), the Great Britain Pound (GBP) and the Japanese Yen (JPY) — each quoted against the rupee. Cross-currency contracts are also traded on EUR-USD, GBP-USD and USD-JPY, where neither leg of the pair is the rupee.
The instruments built on a currency pair are the same family as any other derivative: a currency future fixes today the exchange rate at which two currencies will be exchanged on a future date. A currency option gives the buyer the right, but not the obligation, to buy or sell the underlying currency at a fixed exchange rate within a set period, in exchange for a premium paid to the seller.
A worked example
An Indian exporter expects to receive US$ 1,00,000 in three months and wants to know today what that will be worth in rupees. The relevant currency pair is USD-INR. If the exporter buys a currency future at an exchange rate of Rs 84 per dollar, the rupee value is fixed today at Rs 84,00,000 (1,00,000 × 84), whatever the spot rate does over the next three months.
Had the trade instead involved euros and dollars, with neither leg being the rupee, it would be quoted as the cross-currency pair EUR-USD — the same idea, applied to two foreign currencies at once.
Why NISM asks about it
Chapter 10 (Understanding Derivatives), the currency derivatives section, introduces the currency pair before listing the four exchange-traded pairs and the cross-currency contracts. Expect a question naming the four currency pairs available for trading in India, or asking which two currencies make up a given cross-currency contract.
Common exam traps
- Only four pairs are exchange-traded against the rupee — USD, EUR, GBP and JPY. Do not add other currencies from memory.
- Cross-currency contracts (EUR-USD, GBP-USD, USD-JPY) do not involve the rupee at all. Both legs are foreign currencies.
- A currency option's premium is paid by the buyer to the seller, exactly as with an equity option — do not reverse the direction.
Check yourself
1.On how many currency pairs are currency derivatives available in India, and which are they?
- a)Three: USD, EUR and GBP
- b)Four: USD, EUR, GBP and JPY
- c)Two: USD and EUR only
- d)Five, including the Swiss Franc
Show the answer
Answer: (b) Four: USD, EUR, GBP and JPY
"Currency Derivatives are available on FOUR CURRENCY PAIRS viz. US Dollars (USD), Euro (EUR), Great Britain Pound (GBP) and Japanese Yen (JPY). Cross Currency Futures and Options contracts on EUR-USD, GBP-USD and USD-JPY are also available for trading."
2.In the currency pair USD/INR, what is INR?
- a)The base currency
- b)The quoting currency
- c)The reference currency
- d)The settlement currency
Show the answer
Answer: (b) The quoting currency
"The FIRST currency in the pair is the BASE CURRENCY, while the SECOND is the QUOTING CURRENCY." So in USD/INR the dollar is the base and the rupee the quoting currency. FBIL publishes daily reference rates for USD/INR, EUR/INR, GBP/INR and JPY/INR on Mumbai business days.
Where this is taught
Free preparation for NISM Series X-ARelated terms
- Base and quoting currencyIn a currency pair like USD/INR, the first currency is the base currency and the second is the quoting currency — the rate shows units of the quoting currency per one unit of the base currency.
- Carry costThe interest cost built into the gap between a stock's spot price and its futures price, reflecting the cost of funding a spot purchase until the futures contract's delivery date.
- Interbank segmentThe part of India's spot foreign exchange market where banks quote two-way buy-sell rates to each other, as against the merchant segment, where businesses and retail customers take the price banks offer.