Transaction and Economic Exposure
Tiffany & Co.
Facing Exchange Rate Risks
Following Tiffany & Co. Japan’s new retailing agreement with Mitsukoshi Ltd. in July 1993, TiffanyJapan was now faced with both new opportunities and risks. With greater control over retail sales in its
Japanese operations, Tiffany looked forward to long-run improvement in its performance in Japan despite continuing weak local economic conditions. However, Tiffany was now also faced with risks of exchange rate fluctuations between time of purchase from Tiffany and time of cash settlement that were previously borne by Mitsukoshi.
Managing Tiffany’s yen-dollar exchange rate risk
Historical data warned Tiffany that the yen/dollar exchange rate could be quite volatile on a year-to-year and even month-to-month basis. Although a continued strengthening of the yen against the dollar was observed from 1983 to 1993, there was evidence that the yen was overvalued against the dollar in 1993, and thus a distinct probability that the yen may eventually crash suddenly.
The predicted depreciation of the yen would have a potentially negative impact on Tiffany’s financial results. There are three main types of foreign exchange exposures are (1) transaction (short-term), (2) economic (medium to long term) and (3) translation exposures.
For a company like Tiffany which has sales in numerous countries, there are a continuing series of foreign currency receivables and payables. Thus, Tiffany should have a foreign currency hedging program to cover these foreign exchange exposures. The objective of hedging would be to stabilize product costs, over the short-term, despite exchange rate fluctuations. In the long-term, if exchange rate differences have significantly changed, it is possible to adjust retail prices when necessary to maintain its gross margin.
To reduce exchange rate risk on its yen cash flow,