What Do You Mean by Base Currency?
Base currency refers to a currency that appears first in a foreign exchange pair quotation. In the foreign exchange market, when an individual buys one currency in exchange of another currency, here the base currency will always be quoted in relation to another.
- Base currency is a currency that appears first in a foreign exchange pair quotation.
- The price of the base currency is calculated in the quote currency units.
- The Base currency is also named as transaction currency.
Understanding Base Currency
In the foreign exchange market, we see prices quoted for currency pairs. A currency pair refers to a pair of two different currencies, where the first quoted currency is termed as the base and will be followed by the second currency named as quote currency and is also known as the counter currency. The base currency also termed as transaction currency. Many firms deal in multiple currencies and may use the domestic currency as the base currency to show all profits and losses.
Foreign exchange quotations are defined in pairs because investors buy and sell currencies at the same time. For example, when an investor purchases AUD/JPY, it means that the investor is buying Australian dollar and selling Japanese yen simultaneously. Investors buy and sell in order to get profit. An investor decides to buy only if he thinks he will get profit by purchasing the base currency in contrast with the quote currency. On the flip side, he may sell it if he feels that the value of the base currency will go down in contrast with the quote currency.
In present times, every country is involved in the export and import of goods and services and therefore, import or export firms dealing in multiple currencies. In the foreign exchange market, prices displayed in the quote currency shows the amount of the counter currency an individual needs to pay in order to buy one unit of the base currency.
For example, let’s assume that an investor looking for Pound/USD, in this base currency is the Pound sterling, and the quote currency is the US dollar. If the price of the Pound/USD pair is 1.38840488, it means an investor would need £1.39 to buy a single Dollar.
Frequently asked questions (FAQs)
How is currency pair related to the base currency?
- Currency pair refers to a quotation of price of two distinct currencies, where the first listed currency is called the base currency and the other (second) currency is called as a counter or quote currency.
- In the foreign exchange market, currency pairs help in the calculation of how much amount of quote currency is needed to pay for an exchange of base currency. For example, an investor is interested in a currency pair of Pound/CAN, the Pound Sterling will be the base currency, and the Canadian dollar is the quote currency. In order to get one Pound (base currency), an individual would need to pay an amount of Canadian dollars (the quote currency), which is equal to one Pound.
- Currency pairs used different codes (abbreviations) of currency for pairs which are defined by the International Organization for Standardization (ISO). The different currency codes are JPY, the Japanese yen, EUR for the euro, GBP for the British Pound, CAD for the Canadian dollar, USD for the US dollar, AUD for the Australian dollar and so on. In the foreign exchange market, these codes have been written in a format of XXX/YYY or XXXYYY. Here, XXX indicates base currency while YYY indicates counter currency.
- These codes are used at the time of the foreign exchange convention. According to foreign exchange market convention rule, the price of the base currency is calculated in the quote currency units.
How base and quote currency different from each other?
In the foreign exchange market, the base currency is the first listed currency on a quotation of currency pair. On the other side, the second listed currency is called as counter or quote currency.
The currency pair is a set of two different currencies: base or quote currency. In order to do an exchange, both base and quote currency is important. The price of the base currency is calculated in the price of quote currency. Currency pairs are written in a format of six letters like AAA/BBB. Here, AAA is the first listed currency (base currency), and BBB is the other (quote or counter) currency.
For market convention, both currencies are needed as base or quote. In order to get the base currency, you would need to pay an amount of quote currency which is equal to the base currency. Both base currency and quote (counter) currency are interrelated.
Take an example. Let’s assume the Australian dollar as base currency, and the quote currency is EUR (AUD/EUR). The value of 1 AUD is 0.64412871 Euros. The base will always be one, no matter what currency you use as the base currency. A comparison between these two currencies is called the foreign exchange convention; the base will be the Australian dollar. An investor needs to spend 0.64412871 Euros in order to get one Australian dollar.
On the other hand, if the base is EUR and the quote currency is the Australian dollar. The foreign exchange convention is one Euro equals to 1.5525865 Australian Dollars; it would be the amount of quote currency.