A puzzle

So recently, I was thinking about an imaginary puzzle. Obviously simple to some, but I’m dumb , so you have to indulge me.

Say you saw this snazzy guitar on Ebay, autographed by guitar legend Richie Sambora of Bon Jovi fame, and it’s really underpriced. You reckon that you can earn for yourself a tidy little margin by buying it and selling it for a higher price in Singapore. Because this guitar is one of a kind, so it’s subject to demand fluctuations. Fluctuations based on the current popularity of Bon Jovi as a band, because it is currently making a comeback with 3 new singles in their latest album, you should eventually be able to sell the guitar at a reasonably good profit.

(At this point, it is beginning to sound like a math question from secondary school hell. But moving right along…)

Sounds like you’re all set right? Problem is, you have to pay in USD. Now, we know about the instability of the USD in the current tumultuous market right? And remember, your customers are in Singapore, so they will only buy from you in SGD. So how? The currency might turn against you, and the fluctuations might eventually erode away your profits!

Now, being a finance person yourself, you would want to hedge yourself against this fluctuation right? And obviously, the timing of the hedge is of the utmost importance. Hence,

Question 1: When are you exposed, and when should you set up your hedge?
Question 2: When will you close out your position?
Question 3: What instrument will you hedge this fluctuation with, and why? Take into account transaction costs, risk exposure and the ease of closing out your position/transferring your risk.

Sometime between the time you won the auction and the time your guitar arrived, a scandal broke out. It turns out that Richie Sambora slept with Jon Bon Jovi’s wife, and the band is threatening to break up. Notwithstanding the fact that in times like these the price of memorabilia should go UP, you are of the belief that everyone now hates Sambora, and the value of the guitar is falling as we speak.

Question 4: You need to hedge against the declining value of your asset. What do you do? (Ok, this is MCQ)
A) You go on eBay and sell the item right NOW (you set up a forward position)
B) You conditionally sell the guitar to your brother, who is a Sambora fan, and you make him promise that if the price falls below the margin that you are willing to accept as profit for.. ARGH. Ok this is not fun anymore. The analogy stops here. I am really unproductive at work today.

But I think I did a relatively good job at simplifying a problem I'm having at work. Heh heh.