Lewiston

Tiffany has decided to sell direct in Japan as opposed to selling

wholesale to Mitsukoshi and Mitsukoshi selling to the public. In this

agreement Tiffany will give Mitsukoshi 27% of net retail sales in

exchange for providing the boutique facilities, sales staff, collection of

receivables, and security for store inventory. This new agreement

exposes Tiffany to the fluctuation in the yen-dollar exchange rate.

Therefore, they are considering two basic hedging alternatives to

reduce exchange-rate risk on their yen cash flows. The first alternative

was to sell yen for dollars at a predetermined price in the future using

a forward contract. The second alternative was to purchase a yen put

option allowing them to exercise their option only if it was more

profitable in the future at the future spot rate. Two more alternatives

that we think are appropriate are a synthetic forward using options and

a synthetic forward using interest rate parity. Furthermore, Tiffany

needs to understand the hedging alternatives and determine what, if

any, strategy is right for them.

There are 5 key questions to answer to solve this case correctly and completely.

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?

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

3. If Tiffany were to manage exchange rate risk activity, what should be the objectives of such a program? Specifically, what exposure

should be actively managed? How much of these exposures should be covered, and for how long?

4. As instruments for risk management, what are the chief differences of foreign exchange options and forward or future contracts?

What are the advantages and disadvantages of each? What, if either, of these types of instruments would be most appropriate for

Tiffany to use if it chose to manage exchange rate risk?

5. How should Tiffany...