Let's have a look at FX cross rates a key concept in foreign exchange markets. An FX cross rate is the exchange rate between two currencies that is derived from their respective exchange rates against the common third currency typically, the US Dollar. cross rates exist because many currencies are not traded directly with one another in large volumes. Instead, their rates are determined indirectly through a more liquid currency such as the US Dollar.

For example, on many trading platforms, you might see Euro, South African Rand quoted directly. However, the Euro, South African Rand quote is often derived using more liquid pairs such as the Euro, US Dollar, and US Dollar, South African Rand as intermediaries. This approach leverages the high liquidity of these pairs to ensure more accurate pricing. Let's walk through an example to see how this works in practice. Firstly, we have the Euro US Dollar rate, which is quoted at 1.0652. This means one Euro is worth 1.0652 US Dollars.

Next, we have the US Dollar, South African round rate quoted at 19.2013. This means one US Dollar is worth 19.2013 South African Rand.

To drive the Euro, Rand rate, we assume that one Euro is sold for 1.0652 US Dollars, these $1.07 and then sold for 19.2013 rand per Dollar. This would give 20.4532 South African Rand. So to get to the effective Euro, Rand rate, we simply have to multiply these two rates together. Giving Euro rand equals Euro Dollar times by Dollar Rand. Since the US Dollar is on both sides of the currency, quotations being multiplied together, it's effectively canceled out leaving the exchange rate between Euro and South African Rand. Leaving us with 1.0652 times 19.2013 equals 20.4532 the same number we got to with the previous approach. So the Euro South African cross rates is approximately 20.4532, meaning one Euro is worth 20.45322. South African Rand.

Cross rates are particularly useful in situations where a direct exchange rate is not available or when you want to understand the relationship between two currencies without the involvement of a third one like the US Dollar. However, keep in mind that cross rates often reflect indirect pricing. This means the cross rate is derived from two other exchange rates each with its own bid offer spread as result, the effective bid offer spread on a cross rate can be wider because you are effectively crossing the spread twice, once for each of the intermediary pairs.