International Financial Economics
Universiteit van Amsterdam
Question 1 Should Walt Disney Company hedge its yen exposure? Why?
On April 1983 Tokyo Disneyland started to operate. The Japanese company that operated this park paid royalties on certain revenues to Walt Disney Productions. The Yen royalties receipts in 1984 already reached a height of 8 billion Yen. The director of finance of the Walt Disney Company expected a further growth of 10% to 20% per year over the following years.
In the mean time there existed a problem of a depreciation of the Yen, the Japanese currency depreciated with almost 8% against the US Dollar. The Walt Disney Company was concerned for further depreciation of the Yen Royalties. This was because the amount of royalties was expected to grow at a high level and with a depreciation against the US Dollar this would counter its investment and expansion plans for the future.
To attempt the risk of possible exposure of Disney to future fluctuations in the Yen/Dollar sport rate, the company can choose to hedge its Yen royalties cash flows. This can be done by using financial instruments to reduce or even entirely eliminate the impact of exchange rates on the cash flows of the Yen royalties. These financial instruments include for example forward contracts, futures contracts, swaps and options.
Besides reducing the risk and impact of exchange rates and interest rates, hedging has more advantages. The first advantage is important for Disney since the appreciating Yen will reduce the US Dollar value of the increasing royalties from Japan. Hedging can be used to hold profits and surviving hard market periods, like the depreciation of the Yen. Earnings and cash flows are influenced by exchange rate or interest rate changes which avoids steadiness. With hedging Disney is also not required to monitor daily market volatility and the company can concentrate on its investing and expansion