Tiffany & Co. Case Study
After Tiffany & Co. made the new retiling agreement with Mitsukoshi Ltd in July 1993, Tiffany & Co Japan. Inc started to be responsible to manage the operations of 29 boutiques in Japan. Tiffany will now face both opportunities and risks. Prior to the new agreement, the wholesale transactions were dominated entirely in dollars, so yen/dollar exchange rate fluctuations were not the reason of Tiffany’s cash flow volatility, and Mitsukoshi bore the exchange risk between the purchase and cash settlement. However, with the new agreement, Tiffany is responsible to exchange from yen to dollars to realize its profits and distribute to stakeholders and therefore face the exchange risk.
The exchange risk could be significant to Tiffany since historical data shows that the yen/dollar exchange rate could be quite volatile from year to year and even month to month basis. If the exchange rate declines largely, Tiffany’s profits will be impacted and reduced significantly. Especially since Exhibit 6 shows a continued strengthening of the yen against the dollar was observed from 1983 to 1993, but there was evidence that the yen was overvalued against the dollar in 1993, and thus a distinct probability that the yen may eventually crash.
Therefore, Tiffany needs to actively hedge the yen-dollar exchange rate risk especially from Exhibit 7 considering the potential depreciation of yen which would have a negative impact to Tiffany’s financial results. The yen-dollar exchange rates would have different ways to be exposed to Tiffany’s cash flows, for example, through transactions, medium to long term economic, etc. The chart below will illustrate the financial impact due to exchange rate fluctuation. From exhibit 6, 1993 June exchange rate is 106.5, if it changed to 115 in the next 3 months, then the loss would be $124,923 which is about 10% of the liability without applying any hedging strategy. Scenario
Quaterly Liability (yen)
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