Tiffany Case Study
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?
In July 1993 Tiffany & company had an agreement with Mitsukoshi Limited that changed the business plan in Japan. Tiffany now owns all previously owned stores by Mitsukoshi. 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 and when it ...view middle of the document...
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?
Companies operating in international markets (Tiffany) should always establish management policies on foreign exchange to manage exchange-rate risks. The primary objective is to establish a policy that will minimize the effects of adverse exchange rate fluctuations on the financial position of the company. Tiffany should hedge against its investments to manage exchange rate risks. Some of the exposures in controlling the foreign exchange policy are Transaction exposure, Translation exposure, Operating Exposure and Economic Exposure. The Economic exposure represents the most all-encompassing definition of exposure. Since it represents all transactions, assets and liabilities, recorded or anticipated, that will affect the company’s cash flow when exchange rates change. This is usually associated with a long term (1-5 year) view of exposure management. So, Tiffany should plan to cover the exposures on a long term basis.
4. As instruments for risk management, what are the chief differences of foreign-exchange options and forward and futures contracts? What are the advantages and disadvantages of each? Which, if either, of these types of instruments would be most appropriate for Tiffany to use if it chose to manage exchange-rate risk?
A major difference between option and forwards or futures is that the option holder has no obligation to trade, whereas both futures and forwards are always legally binded agreements. Options can be standardized and traded through an exchange or they can be privately bought or sold, with terms crafted to suit the needs of the parties involved. Futures contracts have clearing houses that guarantee the transactions, which lowers the probability of default to almost never.
An important difference is you must always pay upfront to buy an option because you always have a choice to exercise the option. However when entering in a forward or future agreement you pay nothing at the time of the agreement but are...