Case | HBS Case Collection | December 1994 (Revised June 1995)
Tiffany & Co.--1993
by W. Carl Kester and Kendall Backstrand
The restructuring of Tiffany's retailing agreement with Mitsukoshi Ltd. in 1993 exposed Tiffany to substantial yen/dollar exchange rate volatility that it had not previously faced. This new exposure requires Tiffany to establish risk management policies and practices. Management must determine whether to hedge, what the objective of hedging ought to be, how much exposure to cover, and what instruments to use. Teaching Objective: To introduce students to the problems of risk management in a relatively uncomplicated administrative situation.
Keywords: Restructuring; Currency Exchange Rate; Management Practices and Processes; Risk Management; Agreements and Arrangements; Situation or Environment;
Tiffany & Company 1993
HEDGING THE RISK:
To reduce exchange rate risk on its yen cash flows, Tiffany has two alternatives: 1)
To enter into forward contract: that means to sell yen to the counterparty for dollar at a predetermined price in the future, having short position in the contract. Both parties have obligations to carry out the agreement at expiration. In exhibit 6 there are different forward and spot rates are given. Let's suppose we are standing in June 30, there are two forward rates available in the market, one month forward rate is 106.355 yen per dollar and three month forward is available at 106.330 yen per dollar. No transaction cost is involved in this contract. 2)
To buy yen put option: this option will give tiffany the right but not the obligation to sell a yen at predetermined price in future. From exhibit 8(c) strike prices of put exchange rate are given and premium prices are also given. One month July put option is available at price 1.26 with strike price of 94.0 (that means you will sell 106.3yen for 1 dollar) and another one month put option at strike price 93.5 is sold at 1.22 premium, three month put option is available at 2.06 with strike price of 93.5.