DEFINITION of Key Currency
A key currency is a currency used to set the exchange rate in an international transaction.
WHAT IT IS IN ESSENCE
Key currency is a major currency in the global economy. Small countries, which are highly dependent on exports orientate their exchange rate to major currencies in the global economy, the so-called key currencies. Key currencies include the Euro, the US dollar, the British pound or the Japanese Yen. The term gets attention when deals are agreed between businesses in different countries, they’ll often use it to make the transaction to reduce the risk of exchange rates changing during the deal.
Let’s say some small country has a tiny economy and an unstable government. As a result, the value of its currency is volatile.
For example, some company, which owns the business in that small country, wants to buy equipment from the company which operates in another country. But that country also has a volatile economy and an unstable currency.
So, the second company proposes doing the deal with a key currency: the U.S. dollar. To do the transaction, the first company turns its money into dollars and pays in dollars. The second company receives the dollars and converts them back into its home currency.
HOW TO USE
Aside from cross-border deals, key currencies can also be used by nations to improve confidence in their developing economy. For instance, emerging nations might choose to fix their exchange rates to a more established key currency.
On the foreign exchange market, key currency pairs show how many of one currency can be exchanged for another at a given time. The euro and US dollar form a popular key currency pair.
Key currencies help companies do business with less risk so their transactions won’t be marred by sudden or extreme changes in currency values. Key currencies are also regarded as major global currencies. They usually include the U.S. dollar, the British pound, the euro, the yen, and the Canadian dollar.