Tiffany Case

Question #1 solution:
Tiffany restructured its Japanese operations by selling directly to the Japanesemarket instead of
selling to Mitsukoshi and Mitsukoshi selling it to Japan. Tiffany wanted greater control over its
operations in Japan even though demand for Tiffany’s products in Japan declined from 23%
to 15% in 1992.
However, Tiffany will still be required to pay fees of 27% of net retail sales in compensation to
Mitsukoshi after this restructuring. This change in operations exposed Tiffany directly to the
exchange rate fluctuations which Mitsukoshi previously bore. Previously, Mitsukoshi ensured
that Tiffany never had to worry about exchange-rate fluctuations and guaranteed a certain
amount of cash flows to Tiffany in their wholesale transactions. Mitsukoshi bore the risk of any
exchange-rate fluctuations that took place between the time it purchased the inventory from
Tiffany andwhen it finally made the cash settlement. From exhibit 6 it is shown that yen is
strengthening against the dollar and that will increase the dollar
value of Tiffany’s yen denominated cash flows. But there are some market insights that yen will
overvalue and
crash suddenly.Tiffany should be worried about the exchange rate fluctuations because the
yen/dollar exchange rate isvery volatile. As the value of Tiffany sales was one percent of $20
billion of Japanese jewelry market orapproximately $200 million. Tiffany faced an additional
risk by restructuring its Japanese operations as Mitsukoshi
now no longer controls Tiffany’s sales in Japan.

Question #2 solution:
Tiffany should actively manage its yen-dollar exchange risk. Tiffany knows they willhave
substantial amount of yen cash inflows from their new arrangement of selling direct in Japan. If
Tiffany doesnot hedge this currency exchange risk then their earnings will fluctuate. With
the yen-dollar exchange rate being sovolatile at this time, it is the best time to hedge in order
to help smooth their earnings and reduce risk. Thedownside is that options prices are more
expensive when there is more volatility. Since the yen is thought to beovervalued there is
speculation that it will depreciate in the future compared to the dollar. If the yen depreciatesand
Tiffany converts their yen at the prevailing spot rate then their dollars received will be decreased.
Question #3 solution:
The objectives of managing exchange rate risk should not be to try to make a profiton exchange
rates. Instead the objective should be to reduce risk associated with economic exposure (medium
tolong term) and transaction exposure (short-term). Therefore Tiffany should hedge short term
and then roll theirposition forward. Since the repayment is done on a quarterly basis Tiffany
should cover these exposures for threemonths to adjust their hedging strategy on a quarterly
basis and hedge that amount minus their inventoryrepayment to Mitsukoshi.Economic Exposure;
Tiffany is now exposed to foreign exchange rate risk. Tiffany has to bear the risk ofany
exchange-rate fluctuations that will take place when it assumes the responsibility for establishing
yen retailprice.
Tiffany’s foreign operations performance from 1992 to 199
3 ($000): 1993 Net Sales= $71,838,1994 Net Sales= $52,851, 1993 Income/ (loss) from
operations= $2,381, 1994 Income/ (loss) from operations =$3,888. These i
nformation indicates that income from Tiffany’s foreign operations decreased even though net
sales increased in 1993. The additional economic exposure that Tiffany is now exposed to may
decrease theirincome even further which will impact their net sales in the long run.Transaction
Exposure; the
restructuring of Tiffany’s Japanese operations requires Tiffany to repurchase its
inventory. Tiffany is said to repurchase its inventory for $115 million in 1993. However, Tiffany
only managed to

By: Ramy HassanPage | 2

repurchase $52.5 million of inventory in July 1993 and Mitsukoshi agreed to accept a deferred
payment on$25 million of this repurchased inventory, which was to be repaid in yen on a
quarterly bases with interest of 6%per annum over the next 4.5 years. The remaining $62.5
million inventory will be repurchased throughout theperiod ending February 28, 1998. Since
Tiffany has to repay for inventory returned by Mitsukoshi on a quarterlybasis they can use their
cash flows in yen to repay Mitsukoshi and hedge only the remaining amount
Question #4 solution:
To manage exchange rate risk on Tiffany yen cash flows, Tiffany has twoalternatives, the first
one by buying yen put option: this option will give Tiffany the right but not the obligation tosell
a yen at predetermined price in future. From exhibit 8(c) strike prices of put exchange rate are
given andpremium prices are also given. One month July put options is available at price
1.26 with strike price 94.0, thatmeans Tiffany will sell 106.350 yen for 1 dollar, and another one
month put option at strike price 93.5 is sold at1.02 premium, there month put option is available
at 2.06 with strike price of 93.5.The second alternative by entering into forward contract: that
means to sell yen to the counterparty fordollar at a predetermined price in the future, having
short position in the contract. Both parties have obligations to
carry out the agreement at expiration. In exhibit 6 there are different forward and spot rates are
given. Let’s
suppose we are standing in June 30, there are two forward rates available in the market, one
month forward rateis 106.355 yen per dollar and three month forward is available at 106.330 yen
per dollar. No transaction cost isinvolved in this contract.Options gives the right to option buyer
at cost of premium, but in forward contract it is obligatory for bothparties at no cost. Suppose if
Tiffany enter into 3 month forward contract at 106.330 yen per dollar, and atexpiration in
September the rates goes up in spot to be available at 112 yen per dollar, according to
forwardcontracts its obligatory for Tiffany to sell at 106.330, that means Tiffany will gain 5.67
yen per dollar from thisopportunity.Foreign exchange options you pay the price up front and at
expiration you have the option to exercise. Ifyou buy a call option and at expiration it is in the
money you will exercise your option and buy at the strike price.On the other hand, if the call is
out of the money you will buy in the market place. This means you are not locked into buying at
a set price, but if favorable you have the option to do so. This is beneficial if you are uncertain
you willneed to hedge. A forward contract is usually cheaper and it locks in the exchange rate to
be made at a future date.The downside to a forward contract is that once you enter into it you
have to deliver at expiration. This removesdownside risk because you are guaranteed that
exchange rate, but it also takes away upside potential because youhave to deliver at the specified
rate. Tiffany should use forward contract for three months to match their yenliability. This way,
as the economy and outlook for sales changes, Tiffany can adjust their hedging strategy on
aquarterly basis and hedge that amount minus their inventory repayment to Mitsukoshi.
Question #5 solution:
Tiffany should organize itself to have the treasury department manage theirexchange rate risk.
Since there is no information given that Tiffany has a central department to hedge all of
itsexchange rate risk we are assuming that each location currently hedges its own risk. If this is
the case the CFOshould be responsible for having oversight of managing exchange rate risk, but
an accounting department shouldbe responsible for tracking the profitability of these
transactions. The optimal idea would be to have a centrallocation responsible for managing
exchange rate risk, such as the treasury department. This would reduce costsand reduce the
amount of hedging required. Controls should be in place to ensure that the person responsible
forhedging exchange rate risk does not have oversight over all aspects of the transaction
accounting for andmonitoring the outcome. Such controls should include division of duties for
accounting for profits of such

By: Ramy HassanPage | 3

strategies and the person implementing the strategies. This would provide checks and balances to
ensure thatunnecessary or risky hedging would not take place