(1) What (if any) are the problems confronting the company?
Because of Tiffany’s large exposure in Japan, it is severely adversely affected by the yen/dollar exchange rate fluctuation and needs to determine the best way to hedge against this risk.
(2) How did the problems arise?
Tiffany was assuming control of its operations in Japan, which had previously been managed entirely by Mitsukoshi. With this greater control over its sales in Japan came much increased exposure to exchange rate fluctuations, which was previously borne by Mitsukoshi.
(3) Does the management adequately understand the problems and their causes?
Management does understand the problem they face with large fluctuations in the exchange rate. It is stated that they know that they are now responsible for pricing their merchandise in yen, and how this can and will affect their dollar-denominated profits.
(4) What (if any) solutions to the problems is the management considering?
Management has deduced that it can either employ forward contracts to sell yen for dollars or buy a yen put option.
(5) How good are those solutions?
Either of these options would allow Tiffany & Co to manage its dollar returns, but depending on the anticipated movements of the exchange rate, one can be superior to the other.
(6) What would you do?
I would advise Tiffany and Co to hedge the exchange rate risk using forward contracts.
(7) Why would you do that?
As there is already evidence that the yen may be overvalued, I would choose to enter into a forward contract because there is a premium to be paid for the option contract. Because we would be anticipating a collapse in the value of the yen, if Tiffany were between a forward contract and an options contract with the same exchange rate, the forward would provide the same protection without the added cost of the premium of the option. Only if there weren’t a collapse in the value of the yen versus the...