What Are Leads and Lags?
Let me explain leads and lags in international business—they're about deliberately speeding up or slowing down payments in a foreign currency to benefit from expected shifts in exchange rates. You see, corporations and governments often adjust the timing of these payments if they think currency values will change in their favor.
Understanding Leads and Lags
As someone dealing with international transactions, you can control the schedule of payments you receive or make, within reasonable limits. When it involves a foreign entity, you might choose to pay earlier or later than planned to capture gains from exchange rate changes. This applies to everything from small deals to major ones, like acquiring a company abroad. If the target company's currency is expected to weaken against yours, delaying the payment could save you money. On the flip side, if the currency you're paying out strengthens, it means a smaller payout for you, but weakening would increase costs if you wait too long.
Risks of Leading and Lagging
Keep in mind that leading and lagging is essentially a timing strategy, so it comes with risks—currency rates might move in the wrong direction unexpectedly. When you have a foreign exchange transaction coming up, you may need to buy or sell the required currency. Prices fluctuate based on supply and demand among forex traders, companies, and nations. Most spot transactions settle two business days after the order, but you could lock in a rate with a forward contract. If a currency is expected to drop below the spot price, that's a forward discount, and counterparties use forward points to create discounts or premiums.
Examples of Timing a Foreign Payment
Forecasting exchange rates isn't easy, but some financial and political events follow predictable schedules, giving you clues about rate directions—like elections or budget deadlines. Take Brexit: after the UK's referendum on June 23, 2016, the British pound dropped sharply against the U.S. dollar and hasn't fully recovered as of May 25, 2022. Now, if you're a U.S. company buying a Canadian asset, you'll need to exchange U.S. dollars for Canadian ones. The Canadian dollar fluctuated between about $1.20 and $1.30 against the U.S. dollar in the year ending May 25, 2022. If you expect the Canadian dollar to strengthen, you'd accelerate the payment to avoid higher costs; if weakening, you'd delay to pay less in U.S. terms. But if you're wrong—say, the Bank of Canada hikes rates unexpectedly and strengthens the dollar—delaying could hurt you. Some companies split payments to hedge, paying part now and the rest later.
Key Takeaways
- Leads and lags involve timing payments (advancing or delaying) in international agreements to gain from favorable or anticipated exchange rate changes.
- You can use currency forward contracts and points to adjust future exchange rates up or down.
- Not every currency event is predictable, but many tie to political or financial happenings.
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