Hedging Exchange Rate | Currency risk using Leading and lagging
Let’s imagine you are planning to go to Spain and you believe that the euro will strengthen against your own currency. It might be wise for you to change your spending money into euros now. That would be ‘leading’ because you are changing your money in advance of when you really need to. Of course, the euro might weaken and then you’ll want to kick yourself, but remember: managing transaction risk is not about maximising your income or minimising your expenditure, it is about knowing for certain what the transaction will cost in your own currency. Let’s say, however, that you believe that the euro is going to weaken. Then you would not change your money until the last possible moment. That would be ‘lagging’, delaying the transaction. Note, however, that this does not reduce your risk. The euro could suddenly strengthen and your holiday would turn out to be unexpectedly expensive. Lagging does not reduce risk because you still do not know your costs. Lagging is simply taking a gamble that your hunch about the weakening euro is correct.