Tiffany: Futures Contract and Exchange-rate Risk
Case: Tiffany & Co- 1993 (HBS 298-014)
Assignment Questions
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?
Answer: About 15% of (1992) sales of $492mln or ~ $75mln will now be earned in Yen, but will have to be reported in $. At a Net Income (1992) of $25mln, the risks caused by this exposure are significant. Data from exhibit 6 shows that in a 6-month period (Apr-Sep) exchange rates fluctuated as much as 10%. (from 133.30 ¥/$ to 120.07 ¥/$). A 10% downward fluctuation like this would translate into a third of a drop in net results ($25mln -/- $75mln x 10%) to $16.67mln, assuming everything else stays the same (e.g. all costs incurred in $, prices to consumers remain unchanged).
2. Should Tiffany actively manage its yen-dollar exchange-rate risk? Why or why not?
Answer: Tiffany should actively manage its ¥/$ exchange rate risk for the following reasons: 1. The possible impact on its result as described in the answer to question 1 is significant; 2. There are strong indicators (on a PPP-basis the Yen is highly overvalued) that a correction will occur, which might mean even larger exchange-rate fluctuations than have occurred in the past. The way Tiffany manages its ¥/$ exchange-rate risk is of course a function of how exchange-rate development scenario’s relate to the cost involved in [the instruments used in] managing this riks.
3. If Tiffany were to manage exchange-rate risk activity, what should be the objectives of such a program? Specifically, what exposures should be actively managed? How much of these exposures should be covered, and for how long?
Answer: The objectives of an exchange-rate risk management program should be to put the value at risk within a range that is acceptable for the company, which will depend of the risk appetite of management.
The exposure to be actively managed are
Assignment Questions
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?
Answer: About 15% of (1992) sales of $492mln or ~ $75mln will now be earned in Yen, but will have to be reported in $. At a Net Income (1992) of $25mln, the risks caused by this exposure are significant. Data from exhibit 6 shows that in a 6-month period (Apr-Sep) exchange rates fluctuated as much as 10%. (from 133.30 ¥/$ to 120.07 ¥/$). A 10% downward fluctuation like this would translate into a third of a drop in net results ($25mln -/- $75mln x 10%) to $16.67mln, assuming everything else stays the same (e.g. all costs incurred in $, prices to consumers remain unchanged).
2. Should Tiffany actively manage its yen-dollar exchange-rate risk? Why or why not?
Answer: Tiffany should actively manage its ¥/$ exchange rate risk for the following reasons: 1. The possible impact on its result as described in the answer to question 1 is significant; 2. There are strong indicators (on a PPP-basis the Yen is highly overvalued) that a correction will occur, which might mean even larger exchange-rate fluctuations than have occurred in the past. The way Tiffany manages its ¥/$ exchange-rate risk is of course a function of how exchange-rate development scenario’s relate to the cost involved in [the instruments used in] managing this riks.
3. If Tiffany were to manage exchange-rate risk activity, what should be the objectives of such a program? Specifically, what exposures should be actively managed? How much of these exposures should be covered, and for how long?
Answer: The objectives of an exchange-rate risk management program should be to put the value at risk within a range that is acceptable for the company, which will depend of the risk appetite of management.
The exposure to be actively managed are