Table of Contents

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? 2. Should Tiffany actively manage its yen-dollar exchange rate risk? Why or why not?

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? 4. As instruments for risk management, what are the chief differences of foreign exchange options and forwards or 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 the exchange-rate risk?

Question 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?

Exchange rate risk relates to the effect of unexpected exchange rate changes on the value of the firm. Tiffany & Company are exposed to exchange-rate risk subsequent to its new distribution arrangement with Mitsukoshi due to the fluctuating exchange rate. Yen is usually more volatile and tends to fluctuate in the same direction as the dollar. Yen is also overvalued and could depreciate resulting in lost profits. These risks are fairly serious because they can decrease both profit margin and the value of assets of the company. Not protecting themselves against this exchange rate risk will hurt the companys sales, bottom line, and top line; therefore it is extremely important that Tiffany realizes these risks.

Question 2: Should Tiffany actively manage its yen-dollar exchange rate risk? Why or why not?

Yes, Tiffany should actively manage its yen-dollar exchange rate risk and hedge against this risk because if they did not they would be taking on too much risk. It is very important in terms for reducing a firms vulnerabilities from major exchange rate movements, which could adversely affect profit margins and the value of assets. Also, not hedging against this exchange rate risk allows for being exposed to transaction risk and economic risk.

Transaction risk is the exchange rate risk associated with the time delay between entering into a contract and settling it. The greater the time difference between the entrance and settlement of the contract, the greater the transaction risk due to the fact that there is more time for the two exchange rates to fluctuate. Economic risk is the risk that the firms present value of future operating cash flows will be affected from exchange rate movements. Not hedging against the overall exchange rate risk will negatively impact Tiffany & Company profit margins and lead to exposure or other various types of risk.

Question 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?

To manage exchange rate risk activity, Tiffanys objectives should be to minimize foreign exchange rate risk and lower counterparty risks. We want to minimize these risks because Tiffany & Co. is selling goods that are denominated in US dollars, but sold for yen in the Japanese market. The objective of this program is to prevent the depreciation of the yen against the US dollar by hedging

the currency. The expected Japanese sales of Tiffany & Co. should be actively managed by purchasing hedging contracts continuously on expiration of previous contract.

1. Exchange rate point of view. From the story, Tiffany bought the property and inventory from Japan Mitsukosi. It will expose to the exchange rate translation risk. So it should do the risk management. The analysis structure will be that: (1) Define the risk source: the exchange rate flucturation, the cash flows of different currencies from asset change, account receivable and account payable. (2) Define the scope of risk control: the natural currency settlement hedging, the overflow exchange currency, the future cash flow, the future potential expansion on business. (3) select the hedging tools: forward exchange, options, or futures. What is the portfolio allocation? (4) Allocate the optimal portfolio. It will use the analysis tools. For example, exchange rate with interest rate difference, purchasing powerparity, the option valuation, the forecast of the future trend of exchange rate and the comparison between forward rate and options. This tools are another topics to be discussed. 2.Channel strategy. Why did Tiffany buy the share and operate the business by its own directly? Is there any significant finding and implication for Tiffany? Compare the cost effectiveness of direct channel to indirect channel in luxury business. We may find there are some criteria to be defined. (A) market size, (b)familarity of local market, (c) profit margin, (d) operational efficiency of direct own and indirect. 3. Finance diagnosis. Why did Tiffany make the decision to buy the share from Japan partner? We may use the finance analysis to find some implication. Dupond Equation: ROE=profit margin * asset turnover * leverage. It is a good index to compare the operational efficiency to industry. We can use it to tell the story hidden behind. 4. Luxury business management. Luxury goods creat inelasticity. Many brands control the sales channels and sales volume so as to raise its unit price. There are many typical cases like DeBeers, LV, Carvin Kleir, and Loraile. It is an art

of consumer behavior and customer relationship management. And the finance data is to support the marketing strategy. After the case, I have to study more about the global business management that covers the exchange rate risk management and global financing tools.

Q1: Describe what aspects of the risks in the new arrangement that needs to be managed? 1. Exchange rate point of view. From the story, Tiffany bought the property and inventory from Japan Mitsukosi. It will expose to the exchange rate translation risk. When the dollar falls against foreign currencies, such as the Japanese yen, Tiffany's sales in this foreign country become more valuable when translated back into dollars. For example, in the 1993 Tiffany lose from $25470 to $15712 on Japanese sales due to depreciation of the yen against the dollar.

Exchange rates also directly play a part in domestic sales as they influence foreign tourist spending. When the dollar is weak, U.S. goods are relatively cheap for foreign customers and this leads to higher sales from foreign tourists in U.S. cities such as New York, San Francisco, Las Vegas and other tourist-popular cities. This is particularly important in the New York flagship store where a majority of sales are from foreign tourist purchases.[1]

2. Channel strategy. Why did Tiffany buy the share and operate the business by its own directly? Is there any significant finding and implication for Tiffany? Compare the cost effectiveness of direct channel to indirect channel in luxury business. We may find there are some criteria to be defined. (A) market size, (b)familarity of local market, (c) profit margin, (d) operational efficiency of direct own and indirect. 3. Finance diagnosis. Why did Tiffany make the decision to buy the share from Japan partner? We may use the finance analysis to find some implication. Dupond Equation: ROE=profit margin * asset turnover * leverage. It is a good index to compare the operational efficiency to industry. We can use it to tell the story hidden behind.

4. Luxury business management. Luxury goods creat inelasticity. Many brands control the sales channels and sales volume so as to raise its unit price. There are many typical cases like DeBeers, LV, Carvin Kleir, and Loraile.[2] Q2: A review of what are the risk instruments available to be used? Tiffany has decided to sell direct in Japan as opposed to selling wholesale to Mitsukoshi and Mitsukoshi selling to the public on June 12, 1993. In this agreement, Tiffany will give Mitsukoshi 27% of net retail sales in exchange for providing the boutique facilities, sales staff, collection of receivables, and security for store inventory.[3] This new agreement exposes Tiffany to the fluctuation in the yen-dollar exchange rate. There are three basic hedging alternatives. 1. Forward Contracts /Future Contracts The Company could use foreign exchange forward contracts to offset the foreign currency exchange risks associated with foreign currency-denominated liabilities and intercompany transactions between entities with differing functional currencies. Gains or losses on these foreign exchange forward contracts substantially offset losses or gains on the liabilities and transactions being hedged.[4] 2. Option Contracts To minimize the potentially negative effect of a significant strengthening of the U.S. dollar against the Japanese yen, the Company purchases put option contracts as hedges of forecasted purchases of merchandise over a maximum term of 12 months. The fair value of put option contracts is sensitive to changes in yen exchange rates. If the market yen exchange rate at the time of the put option contract's expiration is stronger than the contracted exchange rate, the Company allows the put option to expire, limiting its loss to the cost of the put option contract.[5] 3. Swap Contracts The Company could enter into interest rate swap agreements to effectively convert certain fixed rate debt obligations to floating rate obligations. Additionally, since the fair value of the Company's fixed rate long-term debt is sensitive to interest rate changes, the interest rate swap agreements serve as a hedge to changes in the fair value of these debt instruments. The Company is hedging its exposure to changes in interest rates over the remaining maturities of the debt agreements being hedged.[6] Furthermore, Tiffany needs to understand the hedging alternatives and determine what, if any, strategy is right for them.

Major Risks Tiffany must prepare to face the following risks in its future growth.

__Further economic downturn: Tiffany's products are expensive items, sensitive to economic downturns with a pronounced effect on sales. In the United States, the large proportion of peoples wealth invested in the stock market amplifies this effect. Additionally because Japan represents a strong percentage of Tiffany's sales, and although the Japanese consumer tends to rely more on savings than the American consumer, any worsening in the Japanese economic outlook will have an effect on sales. 7 __Fluctuation in foreign currencies. A stronger dollar would decrease the contribution of Tiffany's non-US operations (esp. Japan), absent hedging. Tiffany's uses options in order to reduce the exposure to foreign currency fluctuations and must continue to control currency risk. __Outsourcing of finished goods merchandise. Tiffany currently produces in-house only 46% of merchandise offered for sale. Remaining 54% is purchased from third parties with long-standing relationships and highly valued craftsmanship. Although this outsourcing dependency has decreased (was 69% in 1998 and 63% in 1999), it constrains Tiffanys ability to serve customer needs, is difficult to find alternatives in the short term, and exposes the company to currency risk, since 49% of this outsourced purchasing is manufactured outside the US. __Concentration of raw materials suppliers. Tiffany's business depends critically on the sourcing of gems and precious metals. Because 78% of the diamonds can be traced back to a single company (Diamond Trading Corporation), Tiffany started an alliance with a diamond producer from Canada, Aber Diamond Corporation (to provide up to 50% of the diamonds for Tiffany's, starting in 2003). __Loss of design license agreement. Tiffany's has written license agreements which can be terminated by either party with six month's written notice, with earnings negatively affected. These agreements are for exclusive jewelry designs with Elsa Peretti and Paloma Picasso, and account for 18% for net sales in 2000. __Control of Japanese distributor. Tiffanys presence in Japan depends on its commercial relationship with Mitsukoshi as a leading department store operator in Japan.

----------------------[1] http://www.wikinvest.com/stock/Tiffany_&_Co_(TIF)#Yen_Exchange_Rates:_Major_Risks_and_Rew ards_with_Fluctuations_Against_the_Dolla

r [2] http://www.bignerds.com/papers/12374/Tiffany-Case/ [3] http://www.mbacasestudysolutions.com/Fin/Cases/Tiffany_and_Company_1993.html

[4].http://yahoo.brand.edgaronline.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=6921769-134191137882&SessionID=zq9UHC9nzzNBF-7 [5]http://yahoo.brand.edgaronline.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=6921769-134191137882&SessionID=zq9UHC9nzzNBF-7 [6]http://yahoo.brand.edgaronline.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=6921769-134191137882&SessionID=zq9UHC9nzzNBF-7