Not every man suits every woman,

but there is a ring that will .

The Tiffany Setting. Since its

creation over a century ago, the
Tiffany Setting has been the
world's favorite engagement
ring. The ring of rings, as it has
been called, is the most brilliant
ring ever. It is also the most
beautiful. ... Tiffany creates
the most beautiful rings on
earth. Tiffany diamonds are cut
to maximize brilliance.

Tiffany & Company 1993

SITUATIONAL ANALYSIS:
In July 1993 Tiffany & Company made a new retailing agreement with its
Japanese distributor Mitsukoshi Ltd. Under new agreement tiffany & co. is
responsible for operations in Japan, now it's the responsibility of tiffany to
manage the millions of inventory. Previously tiffany sold its inventory to
independent distributors Mitsukoshi on wholesale basis and then Mitsukoshi
resale it in Japanese market on retail basis. Since revenue of tiffany was
realized in dollar and fluctuations in yen/dollar did not affects the tiffany's
expected cash flow. Instead Mitsukoshi bore the risk of yen/dollar exchange
rate fluctuations.
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.
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.

Tiffany & Company 1993

HEDGING THE RISK:

To reduce exchange rate risk on its yen cash flows, Tiffany has two
alternatives:
1) To enter into forward contract: that means to sell yen to the
counterparty for dollar at a predetermined price in the future, having
short position in the contract. Both parties have obligations to carry out
the agreement at expiration. In exhibit 6 there are different forward and
spot rates are given.
Let's suppose we are standing in June 30, there are two forward rates
available in the market, one month forward rate is 106.355 yen per
dollar and three month forward is available at 106.330 yen per dollar.
No transaction cost is involved in this contract.
2) To buy yen put option: this option will give tiffany the right but not the
obligation to sell a yen at predetermined price in future.
From exhibit 8(c) strike prices of put exchange rate are given and
premium prices are also given. One month July put option is available at
price 1.26 with strike price of 94.0 (that means you will sell 106.3yen
for 1 dollar) and another one month put option at strike price 93.5 is
sold at 1.22 premium, three month put option is available at 2.06 with
strike price of 93.5.

Tiffany & Company 1993

RECOMMENDATION TO TIFFANY:
From historical data 1983 to 1993 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(0.00935) for 2.06 (0.000206) would be
more appropriate for tiffany.
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. At 93.5 rate means tiffany will sell 106.97 yen for 1
dollar.

Equation:
(K-ST, 0) = (93.5- 90, 0) = (3.5, 0)
This is total pay off, now deduct the premium
Profit: 3.5-2.06= 1.44 is the profit from this hedging strategy Option is
exercised.

Tiffany & Company 1993

And in another situation 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:
(K-ST, 0) = (93.5- 95, 0) = (-1.5, 0)
In this situation option is not exercised.
Option gives the right to option buyer at cost of premium where as in forward
contract it is obligatory for both parties at no cost.
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.

Tiffany & Company 1993