Group members:G1415626 Ma YunG1410813 Zhang Zuodong

CASE STUDYTIFFANY & COMPANY

1. Company Background 2. Problems And Issues 3. Case Analysis 4. Recommendations

Contents

Tiffany company was founded in New York in 1837 by Charles Lewis. Tiffany company was an internationally renowned retailer, designer,

manufacturer, and distributor of luxury goods. Tiffany and company is a jeweler and special retailing offering an extensive

selection of jewelry, timepiece, china, crystal, silverware and other accessories. From 1986 to 1993, Tiffany opened several flagship retail stores in London,

Munich, Zurich, Hong Kong, Taipei, Singapore, Frankfurt, Toronto, Korea and Japan.

Company Background

Products of Tiffany

•Diversification•84 m to 124 m1979 •Purchase 1.5 m common stock from GECC1989•Wholesale purchase•1991: 23% to 1992: 15% 1992•New agreement•Exchange rate risk1993

Case Background

Facing Exchange Rate Risks

Problems and Issues

In 1993 July, the new retailing agreement made by Tiffany & Co. Japan's with Mitsukoshi Ltd.

With greater control over retail sales in its Japanese operations, Tiffany looked forward to long-run improvement in its performance in Japan despite continuing weak local economic conditions.

However, Tiffany was now also faced with risks of exchange rate fluctuations between time of purchase from Tiffany and time of cash settlement that were previously borne by Mitsukoshi.

Historical data warned Tiffany that the yen/dollar exchange rate could be quite volatile on a year-to-year and even month-to-month basis (exhibit 6). Although a continued strengthening of the yen against the dollar was observed from 1983 to 1993, there was evidence that the yen was overvalued against the dollar in 1993, and thus a distinct probability that the yen may eventually crash suddenly (exhibit 7).

Why Tiffany Faced This Issues?

Exhibit 6

Yen/Dollar Exchange Rate (end of period)

19831984

19851986

19871988

19891990

1991

January

February

March

AprilMay June

July

August

Septem

ber

October

November

December

1992

January

February

March

AprilMay June

July

August

Septem

ber

October

November

December

1993

January

February

March

AprilMay June

0

50

100

150

200

250

300

Yen/Dollar

Japanese Yen: Percent Over-/Under-Valued vs USD

1. Transaction exposure: The restructuring of Tiffany's Japanese operations requires Tiffany to

repurchase its inventory which will significantly decrease its net income. As it can be seen in exhibit 1, Tiffany is said to repurchase its inventory for $115 million in 1993.

2. Economic exposure:Tiffany is now exposed to foreign exchange rate risk. Tiffany has to bear the risk of any exchange-rate fluctuations that will take place when it assumes the responsibility for establishing yen retail price, holding inventory in Japan for sale, managing and funding local advertising and publicity programs and controlling local Japanese management.This may or may not decrease Tiffany's sales and

income from their foreign operations(exhibit 4). 3. Translation exposure: The accounting for translation gains and losses is governed by the statement

of financial accounting standards. Under this accounting method, all foreign assets and liabilities are translate at the exchange rate prevailing on the banlance sheet date(exhibit 2).

What exchange rate exposures Tiffany faced?

exhibit 1: consolidated income statement ($000) 1993 Product return for Japan realignment= ($115,000) 1992 Product return for Japan realignment= 0 1993 Net Income/Loss= ($31,513) 1992 Net Income/Loss= $6,992 However, Tiffany only managed to repurchase $52.5 million of inventory in July 1993 and

Mitsukoshi agreed to accept a deferred payment on $25 million of this repurchased inventory, which was to be repaid in yen on a quarterly bases with interest of 6% per annum over the next 4.5 years. The remaining $62.5 million inventory will be repurchased throughout the period ending February 28, 1998 and payment for this warehouse will be made in yen.

Transaction Exposure

Economic Exposureexhibit 4: Domestic and Foreign Operations('$,000)

Years Earned J anuary 31Domest i c 1992 1993net sal es $439, 055 $414, 558U. S $316, 282 $326, 828export $122, 773 $87, 730I ncome/ ( l oss) f rom operat i ons $98, 229 $73, 559i dent i fi abl e assets $278, 730 $281, 127

Forei gnnet sal es $52, 851 $71, 838I ncome/ ( l oss) f rom operat i ons $3, 888 $2, 381i dent i fi abl e assets $116, 152 $132, 228

income from Tiffany's foreign operations decreased even though net sales increased in 1993. The additional economic exposure that Tiffany is now exposed to may decrease their income even further which will impact their net sales in the long run.

From Exhibit 2: Foreign currency translation adjustment = ($7,665,000)

This shows Tiffany faced the translation risk when they translate the foreign curreny.

Translation Exposure

Yen is usually more volatile and tends to fluctuate in the same

direction as the dollar. Yen is also overvaluedand 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 company's sales, bottom line, and topline; therefore it is extremely important that Tiffany realizes these risks.

How serious these risk?

Tiffany should have a foreign currency hedging program to cover these foreign

exchange exposures.

There are two basic alternatives: (1) Forward agreements (2) To purchase a yen put option

Case Analysis

Forwar

d Contrac

t: an obligati

on

Put Option: a right

The significant difference between forward contract and put option

As we’ve seen form exhibit 6 and 7 just now, it is evident that the yen/dollar

exchange rate could be quite volatile on a year-to-year and even month-to-month basis and the facts regarding the overvaluation of the yen against the dollar is not certain, so there is still some uncertainty about the yen crashing.

Thus, a three month put option at strike price 93.5 for 2.06 would be more appropriate for tiffany.

Which one is suitable?

Exhibit 8 (c)

Column1 Column2 Column3 Column4 Column5 Column6 Column7 Column8 Column9 Column10 Column11C. June 1993 Yen/Dol lar Foreign Currency Option Pri ces(100ths of a cent per yen;each option contract i s for ¥6,250,000strike pri ce Monthly of Maturi ty stri ck pri ce Monthly of Maturi ty

cal l s Jul y August September Puts Jul y August September87 87 0.3689 89 0.5490 90 0.25 0.5 0.9291 3.32 91 1.04

91.5 91.5 0.8592 1.54 2.52 92 0.57 1.07 1.44

92.5 92.5 0.94 1.12 1.6393 1.02 93 1.16

93.5 2.22 93.5 1.22 2.0694 0.94 1.46 1.99 94 1.26

94.5 0.66 1.15 94.595 0.59 1.21 1.33 9596 0.7 0.93 9697 0.55 0.78 9798 0.59 98

For suppose if market spot exchange rate goes down below 93.5 then option

will be exercised at 93.5 and tiffany will gain after deducting the premium price from the strike price.

Equation: Total pay off = Max (strike price-spot exchange rate, 0) = Max(93.5- 90, 0) = Max(3.5, 0) =3.5

Profit = total pay off – premium = 3.5-2.06= 1.44

Strike Price > Spot Exchange Rate

If market spot exchange rate continue to increases and it is higher than strike

price then tiffany will again gain from this situation by not exercising the option, their loss is just premium that is paid and it is limited. But will gain from upside profit potentials.

Equation:

Max (strike price-spot exchange rate, 0) = Max (93.5- 95, 0) = Max (-1.5, 0) =0 In this situation option is not exercised. Option gives the right to option buyer at cost of premium whereas in forward contract it is obligatory for both parties at no cost.

Strike Price < Spot Exchange Rate

Exhibit 8 (b)

B. 1993 Yen/ Dol l ar Exchange Rates(yen per dol l ar) Spot Forward

One month Three monthsJ anuary 124. 8 124. 845 124. 865February 118 118. 015 118. 025March 116. 65 116. 665 116. 675Apri l 111. 6 111. 605 111. 605May 107. 25 107. 255 107. 23J une 106. 35 106. 355 106. 33

For suppose tiffany enter into 3 month forward contract at 106.330 yen per

dollar and at expiration in September the rates goes down now in spot it is available at 102 yen per dollar but according to forward contract its obligatory for tiffany to sell at 106.33, that means tiffany will not gain from this opportunity.

How about the situation when using forward contract?

1. Using the put option to hedge the exchange rate risks that Tiffany faced. 2. In japan, there is a special organization, Keiretsu, which is a large group of

corporations that have strong affiliation with a powerful bank. Usually, the multinational firms within a Keiretsu possess a stronger liquidity position. Therefore, Tiffany can decrease its exchange rate risks via participating this kind of organization.

More details: <The Foreign Exchange Exposure of Japanese Multinational Corporations> by Jia He and Lilian K. NG.

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