The decision of whether or not to hedge the exchange rate exposure ultimately depends on Walt Disney (WD) manager’s attitude about risk and philosophy concerning the proper role of the treasury functions in the overall management of the firm. Arguments can be made for both sides of this issue.
On one hand, if WD is a relatively conservative company in the entertainment and recreation businesses and assuming it could buy insurance against exchange rate fluctuations at a fair price, then it should hedge. Long term planning might also be easier if the currency risk is hedged.
On the other hand, it might be argued that WD has a different perspective on exchange rate movements. While WD might not have been able to predict exchange rate movements systematically, there seemed to be evidence in 1985 that the ¥ was extremely undervalued. Using the data in Exhibit 4 of the case, it would appear that the ¥ has depreciated substantially in real terms, the real rate having gone from ¥225.7/$ in 1980 to ¥284.69/$ in second quarter in 1985 (the real exchange rate, st, is calculated by multiplying the nominal spot exchange rate St, by the ratio of the U.S. CPI index to the Japanese CPI index at time t; thus the real exchange rate in second quarter 1985 was 284.69=250.80 (130.2/114.7). This would suggest that a turn around in the value of ¥ was inevitable sooner or later according to the long term convergence of the exchange rate.
Due to high volatility in the foreign exchange market, recent depreciation of ¥ against the dollar and sensitivity of cash flows to changes in exchange rates, we believe foreign exchange exposure should be hedged.
The main issue that should be looked at is how far into the future should WD hedge. Liquid markets for options and futures contracts existed only for maturities of 2 years or less. Even if the problem with forward contracts is similar, WD obtained an indication of