The effectiveness of freight derivatives in managing a ship-operator's systematic and unsystematic risks

Abstract

The shipping market is notorious for its volatility and risks, with prices in the shipping market fluctuating substantially over short periods of time. While risks do come along with any business venture, the impacts are more pronounced and frequent in the shipping market. Coupled with stiff competition, where only the most adept ship-owners survive in the long-run, the importance of risk management tools have taken on a new meaning where profit maximizing market participants who are more adept at actively managing the unsystematic risks enable them to reduce the risk and thus, a higher stability in their earnings. Today, a myriad of hedging tools exist for a ship-operator, with the most recent development being freight derivatives. The paper‟s objective is to determine the effectiveness of forward freight agreements in hedging the systematic and unsystematic risks faced by a ship-operator with tonnages primarily operating on the spot market by comparing with the traditional methods of hedging. This will be done through the creation of a shipping asset portfolio model which simulates a real-life ship-operator‟s portfolio. This research is of high commercial significance, as the findings can demonstrate how freight derivatives complement the highly capital intensive business of shipping in terms of performance and utility – thereby providing a vital reference for the ship-operator.