What is Leads And Lags
Leads and lags is the alteration of normal payment or receipts in a foreign exchange transaction because of an expected change in exchange rates. Depending on the transaction and the expected movement in a currency, a payment can be both sped up or slowed down.
Leading and lagging is not always advantageous.
BREAKING DOWN Leads And Lags
When a business has an expected foreign exchange transaction as a result of a deal, it may need to buy or sell a certain currency. If the company believes the currency may move in a certain direction they may choose to speed up the transaction or delay it to take advantage of the potential outcome.
Accelerating transactions is known as "leading" while slowing it down is known as "lagging." For example, if a U.S. company has agreed to buy a Canadian asset it will need to buy Canadian dollars and sell U.S. dollars to complete the transaction. If the company believes the Canadian dollar is going to strengthen against the U.S. dollar they will accelerate the transaction (lead) before the price of the asset increases in U.S. dollar terms.
Conversely, if the company believes the Canadian dollar will weaken, they will hold off payment (lag) in the hope the asset becomes cheaper in U.S. dollar terms.
There are risks with leading and lagging in that the move in the currency may not go as expected. For example, if the company that is buying the Canadian asset chooses to hold off payment because it believes the Canadian dollar will weaken, and before making the payment the Bank of Canada (BoC) unexpectedly raises interest rates, the Canadian dollar will strengthen making their decision to hold off detrimental. For this reason some companies will choose to make part of the payment at the time of agreement and wait to pay for the remainder.