In what way(s) is Tiffany exposed to exchange-rate risk subsequent to itsnew distribution agreement with Mitsukoshi? How serious are these risks?Answer: About 15% of (1992) sales of $492mln or ~ $75mln will now be earned inYen, but will have to be reported in $. At a Net Income (1992) of $25mln, the risks caused by this exposure are significant. Data from exhibit 6 shows that ina 6-month period (Apr-Sep) exchange rates fluctuated as much as 10%. (from 133.30 ¥/$ to 120.07 ¥/$).
A 10% downward fluctuation like this would translate into a third of a drop in net results ($25mln -/- $75mln x 10%) to $16.67mln, assuming everything else stays the same (e.g. all costs incurred in $, prices to consumersremain unchanged).1.In what ways is Tiffany exposed to exchange-rate risk subsequent to its new distribution agreement with Mitsikoshi? How serious are these risks?Tiffany is exposed to foreign exchange risk by selling directly to the Japanesemarket. When they sold wholesale to Mitsukoshi, Mitsukoshi bore all the foreign exchange risk. Under this new agreement Tiffany is now exposed to the volatile fluctuations in the yen-dollar exchange rate. Since Tiffany is making profits in yen they have to convert the yen to dollars to take back to their home country. Since the yen is thought to be overvalued in comparison to the dollar, the future exchange rate can decrease Tiffany’s profits.
Also, the extreme volatility in the exchange rate creates significant uncertainty in what the future exchange rate and profits will be if left unhedged. The most important foreignexchange risk facing Tiffany is…2. Should Tiffany actively manage its yen-dollar exchange-rate risk? Why or why not?Answer: Tiffany should actively manage its ¥/$ exchange rate risk for the following reasons:1. The possible impact on its result as described in the answer to question 1is significant;2. There are strong indicators (on a PPP-basis the Yen is highly overvalued) that a correction will occur, which might mean even larger exchange-rate fluctuations than have occurred in the past.The way Tiffany manages its ¥/$ exchange-rate risk is of course a function of how exchange-rate development scenario s relate to the cost involved in [the instruments used in] managing this