Base currency

Base currency

Trading in the foreign exchange market involves buying one currency and selling another in pairs. The base currency is the first of the two currencies in a team, and the quote currency is the second. It evaluates the worth of two coins, i.e., the base currency and the quote currency.  

The base currency in forex is the amount of the quoted cash required to buy one unit of the base currency. For instance, if you were looking at the CAD/USD currency pair, the Canadian dollar would be the base currency, and the US dollar would be the quote currency. 

What is base currency? 

Prices for individual currency units are offered as currency pairs on the forex market. A currency pair quotation always starts with the base currency, the transaction currency, and ends with the quote currency, also known as the counter currency. A company may reflect all gains and losses in its accounting by using the base currency as domestic or accounting currency. 

Understanding a base currency 

All forex transactions require the simultaneous buying and selling of two different currencies, but the currency pair itself can be viewed as a single instrument that can be bought or sold. You purchase the base currency and sell the quote currency when buying a currency pair from a forex broker.  

On the other hand, if you sell the currency pair, you receive the quote currency instead of the base currency. Base currencies are present in currency transactions since a currency pair is constantly exchanged. A trader who purchases US dollars using sterling buys USD and sells GBP.  

Currency pairings appeal to businesses that operate abroad and transact in different currencies. The USD/GBP or GBP/USD currency combination is useful for a British company that transacts business in US dollars. 

Factors that impact base currency 

The following are the factors that impact base currency: 

• Currency exchange rates and currency pairs fluctuate due to changes in market inflation. The value of a nation’s currency will rise if its inflation rate is lower than that of another. Where inflation is low, prices of products and services rise more slowly. While a nation with higher inflation normally experiences currency depreciation and higher interest rates, a country with persistently lower inflation typically sees growing currency values. 

• Interest rates will likely drop in a recession, making it harder for the nation to attract foreign investment. As a result, its base currency loses purchasing power against the currencies of other countries, which lowers the exchange rate. 
• Currency value and the dollar exchange rate are affected by changes in interest rates. Interest rates, foreign exchange rates, and inflation are all interconnected. As higher interest rates provide lenders higher rates, which attracts more foreign money and raises exchange rates, a country’s currency gains value in reaction to increases in interest rates. 
• Government debt decreases a nation’s ability to attract foreign investment, which increases inflation. Foreign investors will sell their bonds on the open market if the market anticipates government debt in a particular country. The value of its base currency will consequently decline. 

Base currency examples 

The idea of the base currency is understood from the following example.  

 In 2023, Jin has plans for a vacation in New York. He is an English resident who exclusively carries pounds sterling. He thus visits the currency exchange with the intention of converting his GBP to USD. According to the store assistant, the exchange rate is GBP/CAD = 0.82. That indicates that 0.82 GBP is equal to 1 US$. 

 In our illustration, the quotation currency is GBP, and the base currency is USD. As a result, Johnny may swap £ 0.82 GBP for 1 US$ at the currency exchange. 

Working of base currency 

In currency trading, you buy the base currency and sell the other. Local changes in interest rates, trade imbalances, and economic expansion can make one currency more preferred. Trading occurs in off-exchange marketplaces and regulated exchanges known as forex (short for “foreign exchange”).  

“Pips,” total quotation units, are used for currency pairs. A pip is the fourth digit in a quote following the decimal point and represents.01% of one team of money. Currency pairings have bid-ask prices, just like stocks. The customer pays the required price, and the vendor receives the bid amount. The market maker receives payment for the spread, the difference between the two prices.  

Exchanges compete on spread costs to draw customers. The minimum investment for trading is 100,000 units of the base currency, a sizable sum. Yet, the minimum margin needed to trade in cash can be as low as 2%, depending on the currency pair. 

Frequently Asked Questions