Study of Case Tiffany & Co. – 1993

The new agreement between Tiffany & Co. and Mitsukoshi brought, to Tiffany, a greater control over retail sales in its Japanese operations, as well as a greater exposure to the foreign currency fluctuations, which used to be borne by Mitsukoshi. Even though a continued strengthening of Yen has gone straight up against Dollar from 1983 to 1993, past history indicated that the yen/dollar exchange rate could be quite volatile on a year-to-year, or even month-to-month basis. And there was the distinct possibility that the yen might eventually become overvalued and crash suddenly. As we could tell from 2015, the yen collapse in August 1998, and did not got recover until 2011.

The great fluctuation of yen’s value could bring great volatility to the Tiffany’s revenue, since, in Japan, the transactions were denominated entirely in yen. Especially a crash of yen, with an exposure of $200 Million, would cause tremendously loss to Tiffany. Therefore, Tiffany should actively manage its yen-dollar exchange-rate risk.

For a company like Tiffany, the main foreign exchange exposure is the continuing series of receivables and payables in foreign currency. Therefore, Tiffany should actively hedging the foreign exchange fluctuation to cover the short-term exposure. The objective of hedging the foreign exchange fluctuation is to stabilize the value of COGS and Sales over the short-term. In long-term, Tiffany could cover the foreign exchange volatility by changing marketing strategy or adjusting prices.

Like the article says, the major two methods that Tiffany could use to hedge the exchange-rate risk on its yen cash flows are 1. Enter a forward agreement and 2. Long a yen put option. Both two methods would help Tiffany achieves its goal, but are different in many ways.

Forward:

A forward is a contract that enforces the entered two parties trade a specific product(s) at a specific price at a specific future date. Both the long and short side of a forward...