Posted in Finance, Accounting and Economics Terms, Total Reads: 359
Definition: European Currency Unit – ECU
European Currency Unit was an artificial currency made up of a basket of 12 currencies of the European Union Member states. ECU was formulated in 1979 as an internal accounting unit by the member states and it was replaced by Euro in 1999. The exchange rate between the EU member states was based on each currency’s value in the ECU.
ECU was a weighted index of the currencies of the member countries which provided a mechanism to adjust the fluctuations in exchange rates between countries which participated in the ECU. The weightage was calculated as a percentage of each country’s share in EU’s total production. ECU acted not only as an inter-state exchange rate but also minimized the risk for foreign investors by providing diversification and not relying only on a single currency for a particular transaction. For e.g. A U.S investor investing in French bonds had interest rate risk as well as exchange rate risk with respect to Francs. After the implementation of ECU, he would invest in bonds denominated in ECU thereby minimizing his reliance on Francs and diversifying his risk across 12 currencies.
The value of ECU with respect to any other foreign currency (e.g. USD) was calculated by dividing each currency in the basket by the corresponding exchange rate of member state currencies with respect to the target currency (e.g. French Francs/USD, Great Britain Pounds/USD) and then adding the twelve numbers together to obtain the USD/ECU rate.
The composition of the ECU basket between 1989 and 1999 is shown above