In July 1993, Tiffany & Company reorganized its Japanese distribution channel by repurchasing its inventory from its Japanese distributor Mitsukoshi Limited. As a result of this action, Tiffany would assume the responsibility of establishing yen retail prices, holding inventory in Japan for sale, and controlling local Japanese management. Tiffany would be able to have control over retail price in Japan where historically had higher price. Under the previous arrangement, Tiffany contracted Mitsukoshi as the principal retailer in Japan and the transaction of wholesaling to Mitsukoshi was settled in U.S. dollar, under the new agreement, Tiffany now faced the risk of foreign currency fluctuations.
Reasons for Managing Exchange Rate Risk
Tiffany should actively manage its yen-dollar exchange rate risk for several reasons:
* Exchange rate fluctuation increases the cash inflow volatility, which could in turn affect Tiffany's cash position and tax implication,
* Historically yen/dollar exchange rate has been volatile,
* Management can concentrate on its main business,
* The cost of hedging or insurance was not substantial, cost is zero on average if the forward rate equals the expected spot rate,
* There exists efficient foreign currency markets that Tiffany can rely on
Tiffany's sales in Japan was about $200 million (1% of the $20b Japan market), which is sufficiently large compared with the $18.0
million anticipated capital expenditures in FY 1993. Moreover, the $115 million reversal of inventory from Mitsukoshi which would be repurchased over the next 4 ÃÂ½ year also presented a large amount of cash flow that could have large fluctuations if left unprotected. [this amount will be paid out in yen , so it won't really be affected by the Yen/S exchange rate as Tiffany's can just use cash flows from its sales in Japan to pay. Therefore their main concern as far as...