Base Currency

The Base Currency is the first currency listed in a currency pair and always represents one unit. Think of it as the “thing” you are buying or selling. For example, in the popular pair EUR/USD, the Euro is the base currency. If the exchange rate is 1.10, it means 1 Euro (the base currency) costs 1.10 U.S. dollars (the quote currency). For investors, the term also has a broader, more personal meaning: it's your “home” currency—the currency of the country where you live and in which you measure your wealth and investment performance. An American investor's base currency is the U.S. Dollar (USD), while a French investor's is the Euro. Understanding this dual meaning is vital, as it's the foundation for navigating international investments and managing the sneaky effects of currency risk.

The term “base currency” wears two different but related hats in the investment world. It's crucial to know which one people are talking about.

In the world of foreign exchange (Forex) trading, every transaction involves a pair of currencies. The base currency is the star of the show.

• It's always listed first (e.g., the GBP in GBP/USD).
• It always has a value of 1.
• The number you see—the exchange rate—is how much of the second currency (the quote currency) you need to buy that single unit of the base currency.

Example: If you see CAD/JPY = 85.00, it means:

• Base Currency: Canadian Dollar (CAD)
• Quote Currency: Japanese Yen (JPY)
• It costs 85.00 Japanese Yen to buy 1 Canadian Dollar.

For a value investor, this is arguably the more important definition. Your base currency is your financial “home base.” It's the currency you use for your accounting, performance tracking, and ultimately, spending your returns. If you are an American investor buying shares in a German company, you might buy the shares in Euros, but your brain is constantly translating the performance back to U.S. Dollars. Why? Because you'll eventually use those profits to buy goods and services in the U.S. Your entire portfolio's success is ultimately measured in your base currency. This is where currency fluctuations can either be a surprise bonus or a painful drag on your returns.

A true value investor looks beyond just the stock price. Finding a wonderfully undervalued company is only half the battle if it's located in another country. You must also form an opinion on the long-term prospects of its currency relative to your own base currency.

Let's say you're a UK investor (base currency: GBP) and you find a fantastic, cheap American company. You invest, and over the next year, the stock soars 20% in USD terms. A brilliant success! Or is it? If during that same year, the U.S. Dollar weakens by 25% against the British Pound, your brilliant investment is now a loss. When you convert your bigger pile of dollars back into pounds, you get fewer pounds than you started with. This is currency risk in action. A wide margin of safety on a foreign stock can be completely wiped out by unfavorable exchange rate movements. Therefore, a value analysis of a foreign company must include a basic assessment of currency stability and trends.

Let's walk through a scenario to see how this plays out.

1. Investor: An American, so their base currency is USD.
2. Investment: Wants to buy €10,000 worth of shares in a French company.
3. Starting Exchange Rate: EUR/USD = 1.15 (1 Euro costs $1.15).

To get the required €10,000, the investor sells dollars.

• Cost in base currency (USD) = €10,000 x 1.15 = $11,500.

One year later, the French shares have risen 30% and are now worth €13,000. On paper, a fantastic return.

However, during that year, the Euro has weakened against the Dollar.

• New Exchange Rate: EUR/USD = 1.08 (1 Euro now only costs $1.08).

The investor sells the shares for €13,000 and converts the proceeds back to their base currency (USD).

• Cash received in USD = €13,000 x 1.08 = $14,040.

The stock return in its local currency was a whopping 30%. But the return measured in the investor's base currency tells the real story.

• Initial Investment: $11,500
• Final Value: $14,040
• Profit in USD: $2,540
• Real Return: ($2,540 / $11,500) = 22.1%

The 8% difference between the stock's local return (30%) and the investor's actual return (22.1%) was eaten by the currency shift. In this case, it was still a great investment, but it demonstrates how essential it is to consider your base currency when venturing abroad.