A currency basket, also known as a currency composite or currency index, is a collection of different currencies grouped together and weighted by a specific methodology.
The primary purpose of a currency basket is to provide a benchmark or measure the value of one currency against a group of other currencies, rather than a single currency pair.
Currency baskets are often used by central banks, multinational corporations, and investment funds to manage their currency exposure, hedge against currency risks, or implement investment strategies.
For example, the International Monetary Fund (IMF) uses a currency basket called the Special Drawing Rights (SDR) to supplement the official reserves of its member countries.
The SDR is composed of five major currencies: the U.S. Dollar, Euro, Chinese Yuan, Japanese Yen, and British Pound, with each currency assigned a specific weight based on its importance in international trade and finance.
Currency traders and investors can also use currency baskets to diversify their portfolios, hedge against risks, or gain exposure to specific regions or economic sectors.
For instance, a trader who wants to invest in the Asian market might create a currency basket composed of multiple Asian currencies, such as the Japanese Yen, Chinese Yuan, and South Korean Won, to spread their risk across several currencies rather than focusing on a single currency pair.