Tiffany: Futures Contract and Exchange-rate Risk

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Case: Tiffany & Co- 1993 (HBS 298-014)

Assignment Questions

1. In what way(s) is Tiffany exposed to exchange-rate risk subsequent to its new distribution agreement with Mitsukoshi? How serious are these risks?

Answer: About 15% of (1992) sales of $492mln or ~ $75mln will now be earned in Yen, but will have to be reported in $. At a Net Income (1992) of $25mln, the risks caused by this exposure are significant. Data from exhibit 6 shows that in a 6-month period (Apr-Sep) exchange rates fluctuated as much as 10%. (from 133.30 ¥/$ to 120.07 ¥/$). A 10% downward fluctuation like this would translate into a third of a drop in net results ($25mln -/- $75mln x 10%) to $16.67mln, assuming everything else stays the same (e.g. all costs incurred in $, prices to consumers remain unchanged).

2. Should Tiffany actively manage its yen-dollar exchange-rate risk? Why or why not?

Answer: Tiffany should actively manage its ¥/$ exchange rate risk for the following reasons: 1. The possible impact on its result as described in the answer to question 1 is significant; 2. There are strong indicators (on a PPP-basis the Yen is highly overvalued) that a correction will occur, which might mean even larger exchange-rate fluctuations than have occurred in the past. The way Tiffany manages its ¥/$ exchange-rate risk is of course a function of how exchange-rate development scenario’s relate to the cost involved in [the instruments used in] managing this riks.

3. If Tiffany were to manage exchange-rate risk activity, what should be the objectives of such a program? Specifically, what exposures should be actively managed? How much of these exposures should be covered, and for how long?

Answer: The objectives of an exchange-rate risk management program should be to put the value at risk within a range that is acceptable for the company, which will depend of the risk appetite of management.

The exposure to be actively managed are...
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