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PZK Co, whose home currency is the dollar, trades regularly with customers in a number of different countries. The company expects to receive €1,200,000 in six months’ time from a foreign customer. Current exchange rates in the home country of PZK Co are as follows:
spot rate 4.1780 4.2080 euros per $
6- month Forward: 4.2302-4.2606 euros per $
Twelve-month forward exchange rate: 4.2825-4.3132 euros per $
The interest rate in the home country of PZK Co is 4% per year.
As well as considering the use of derivatives to hedge the risk exposure presented by the receipt, the treasurer of PZK is looking at ‘internal methods such as invoicing in dollars and leading and lagging.
With reference to PZK making foreign currency purchases, which of the following statements concerning whether PZK Co should ‘lead’ or ‘lag’ in its management of the anticipated receipt is true?
A The $ is expected to weaken against the €, so PZK should leadB The $ is expected to weaken against the €, so PZK should lag
C The $ is expected to strengthen against the €, so PZK should lead
D The $ is expected to strengthen against the €, so PZK should lag
Answer is C. However, I was stucked between B and C. Can you tell why B is not right?
The $ is expected to buy more €’s and therefore the $ is expected to strengthen, not to weaken
That’s why we will try to lag.
If we knew that after some time dollar is going to fall against euro so we will wait so that in future we can convert more dollars from same amount of euros.
How it wrong then?As to whether they will lead or lag depends on what currency they operate in and what currency they are having to pay in. You have not copied that information from the original question.
It is mentioned: Home Currency is Dollar so it make foriegn currency euros. Company is going to receive €1200k.
Can you help me now?
The longer they lag the payment, then because the dollar is weakening, the more dollars they will receive when they convert the euros.
I am awfully sorry for causing you confusion.
As I wrote in my earlier reply, the dollar is expected to strengthen (not weaken).
However are you sure that you have copied the question correctly because the last paragraph says in reference to foreign currency purchases what should the do about a foreign currency receipt?
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