1. In what ways was Tiffany exposed to currency risk under the old arrangement?

Under the old arrangement:

Tiffany sold its inventory to independent distributor Mitsukoshi on wholesale basis.

Mitsukoshi in turn resold the merchandise it acquired into the Japanese market on retail
basis. Thus, Tiffany revenues from Japan was realized in dollar and fluctuations in
yen/dollar did not affects the Companys expected cash flow. Instead, Mitsukoshi bore
the risk of yen/dollar exchange rate fluctuations.

How about under the new arrangement?

Under the new arrangement:

Tiffany is exposed to foreign exchange risk as it is now selling directly to the Japanese
market. Unlike the old arrangement, where Mitsukoshi bore all the foreign exchange risk.
Tiffany is now exposed to the volatile fluctuations in the yen-dollar exchange rate. One
can infer that Tiffany now faces the following currency exposure risks:

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.

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).

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 balance
sheet date (exhibit 2).
2. How serious is Tiffanys yen-dollar risk?

Exchange rate risk relates to the effect of unexpected exchange rate changes on the value
of the firm. Tiffany is exposed to exchange-rate risk subsequent to its new distribution
arrangement with Mitsukoshi due to the fluctuating exchange rate. The case states that
the Yen is usually more volatile and tends to fluctuate in the same direction as the dollar.
Furthermore, the Yen is also overvalued and could depreciate resulting in lost profits.
Based on the above, one can conclude that these risks should be taken seriously since
they have the possibility of negatively affecting both profit margin and the value of
assets of the company balance sheet. Ignoring these potential these potential exchange
rate risk could negatively affect the companys bottom line, and top line.

Supporting data: 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 (E. 7)

From exhibit 6 it is shown that yen is strengthening against the dollar and that will
increase the dollar value of Tiffany's yen denominated cash inflows. But there are some
market insights that yen will overvalue and crash suddenly.

Quantifying the exposure:

Based on the information from the case:
In 1992, Tiffany generated ~15% of total sales of $492m in Yen. Thats ~ $75m in sales
that if everything else remains unchanged will now be generated in the local currency,
Yen.
From an net income standpoint, net income of $25m, the risks caused by this exposure
are significant. A 10% downward fluctuation like this would translate into a third of a
drop in net results ($25m -/- $75m x 10%) to $16.67m, assuming everything else stays
the same.
3. How will the proposed deal create economic value for Tiffany? For Mitsukoshi? Your
answer should address, and even focus on, issues unrelated to currencies.

Now tiffany faces both opportunities and risk as well. As Japanese market is large and
growing market that will increases the sales and profits with greater control over retail
prices. But now tiffany has to bear the exchange rate risk that previously borne by
Mitsukoshi.

One would need to compare the cost effectiveness of direct channel to indirect channel in
luxury business by identifying some criteria such as market size, operational efficacy
capabilities; familiarity of local market, and profit margin growth potential.

We should note that operating directly into the space will allow Tiffany to obtain
valuable insights about the local customer and local market practices and build internal
expertise on how to cater Tiffany products to local clientele. They will also be able to
dictate retail pricing, which until now was controlled by Mitsukoshi and perhaps expand
on its distribution channels.

It should also be noted that Tiffany sees a strong growth potential in the Japanese market,
and because Mitsukashi does not possess the required capital to pursue these
opportunities, Tiffany has now build the stage to go after these opportunities.

For Mitsukoshi, it gets to enjoy the benefit of being one of Tiffanys largest institutional
investors, but watching their investment in the company grow, if it succeed. Additionally,
the influx of cash allow them to pursue other profitable avenues within their purchasing
abilities.