Due to the fluctuations of yen/dollar exchange rate, the new distribution agreement with Mitsukoshi gave rise to high exchange-rate exposure for Tiffany to bear. The exposure goes in the following two ways:
Economic Exposures. From 1983 to 1993, the yen/dollar exchange rate was along a down turn path (see Exhibit 1). In the past, Tiffany wholesaled its products to Mitsukoshi. Since the wholesale transactions were denominated entirely in dollars, yen/dollar exchange rate fluctuations did not represent a source of volatility for Tiffany's expected cash flows. Under the new agreement, Tiffany has to bear the risk of any exchange-rate fluctuations that will take place when it assumes the responsibility for establishing yen retail prices, holding inventory in Japan for sale, managing and funding local advertising and publicity programs, and controlling local Japanese management.
Translation exposure. Since Tiffany-Japan is a wholly owned subsidiary of Tiffany, as a public company, Tiffany has to consolidate financial report of its Japanese branch.
English: Mechanism of Fixed Exchange Rate System
English: Exchange Rate Regimes
Example from the Mundell-Fleming model, flexible e...So, an unanticipated change in yen/dollar exchange rate will effect the company overall financial performance.
Since Japan's sales in 1991and 1992 accounted for 23% and 15% of the net sales of Tiffany along with the long-run growth potential of Japanese sales, the above two sorts of risks could be severe in the case of an unexpected change of yen/dollar exchange rate. For example, when an unanticipated 10% rise of yen against dollar exchange rate comes, Tiffany will probably reconsider the inflated budgets in dollar term of Japanese advertising and publicity programs.
Considering the potential harms brought by yen/dollar exchange-rate exposures, Tiffany should actively manage the risk. Despite the huge market potential for Tiffany's jewelry in Japan, Japanese consumers became more cautious in their spending as the Japanese economy slowed down, resulting in a slumped demand for Tiffany's luxury items. And in the $20...