Freight derivative

Presented by:
Ankush Sinha
31
AnoopSharma
32
Archit Khare
33
Arti Sood
34
Arun Dalal
35
Baishali Sen
36
Chinamaya Dash
37
 Roadmap
1. Current Developments in
Shipping Markets
2. Fundamentals of Shipping
Markets
3. Highly cyclical shipping
industry
4. Forward Freight
Agreements (FFAs)
5. Underlying asset
6. Quotes Duration
7. Trading
8. Market Participants
9. Role of the Baltic Exchange
10.Indices
11.Baltic Capesize Index (BCI)
•
• INDIA
•
12.FFA Settlement
13.Freight Rate Formation in
the Market
14.World scale
15.TD3 -Example Trades
16.TD3 Options
17.Uses of FFAs
18.Uses of FFAs: Forward
Curves
19.Uses of FFAs: Trading
Opportunities
20.Risks
21.Dealing with Credit Risk
22.FFAs – Future Trends
23.Freight Derivatives in
 Current Developments in
Shipping Markets
•
• Freight as a new commodity
• High volatility in the shipping markets
– Sharp fluctuations and sudden changes in
the market
• Entrance of new players in the shipping
markets
– trading houses and energy companies as
well as investment banks and hedge funds
•
 Fundamentals of Shipping
Markets
• Freight rates reflect the cost of
transporting bulk commodities by sea
across different parts of the world
• Market Segmentation
– Across Type of Commodity
• Wet Market: Transportation of Crude Oil and
Oil products
• Dry Market: Dry Bulk Commodities – Grains
and agricultural, Coal, Iron Ore etc.
– Across Sizes
• Commodities are transported in different sizes
according to their Parcel Size Distribution
Function
Highly cyclical shipping
industry
 Forward Freight Agreements
(FFAs)


 An FFA is a Swap
– Principal to Principal contract with a buyer
and a seller
– An agreement today to buy or sell a freight
rate at a
– Certain level for a defined period in the
future.
– To settle at a future date at a price based on
freight


• Cash settled
• Flexible periods (12 to 36 months horizon
can go to 10 years)
• Tradable on different routes and vessels
 Underlying Asset
• Freight rate
o Prices in the freight market are termed
freight rates
o Are expressed in terms of $/day (“time-
charter”) or $/tonne (“voyage charter”)
o
• The freight market is highly segmented
and freight rates are specific to:
– Vessel type
– Route
– Duration of charter agreement
 Quotes Duration
• Prices are listed monthly for the first
six months
• Quarterly for six more quarters then
• Calendar quotes are posted for two
years out.
•
 Accordingly 2-4 year quotes are
provided
 Trading
• Exchange traded
 Settled against various freight rate indices
published by the
– Baltic Exchange (for Dry and most Wet
contracts) &
– Platt's (Asian Wet contracts).
•
• FFAs are often traded over-the-counter
– Through broker members of the Forward
Freight Agreement Brokers Association -
FFABA
– Example :Clarkson's Securities, SSY -
 Market Participants
• Ship owners
• Charterers
• Banks
• Brokers
– GFI, Prebon and TFS
• Investment Banks
– Morgan Stanley, Barclays Bank
• Oil companies
– BP, ConocoPhillips, Shell and Total
• Hedge Funds
• Clearing Houses
– NOS,LCH
 Role Of Baltic Exchange
• Responsible for standardizing a set of
routes
• Sets the rules and oversees the
process of collecting and
processing the brokers’
assessments of freight rates in
more than 40 cargo routes 
• Settlement Rates :Average of the
rates for the contract route over
the contract period
 Indices
• Dry Market
– Baltic Capesize Index (BCI)
(150,000+ dwt)
– Baltic Panamax Index (BPI) (70,000+
dwt)
– Baltic Supramax Index (BSI)
(52,000+dwt)
• Wet Market
– Baltic Tanker Index (Dirty and Clean)
– Baltic LPG Index (44,000cbm)
– Platts Assessments
•
 Baltic Capesize Index (BCI)
FFAs can be traded against any of these
individual routes or against the averages
of Routes 8 to 11
Most trades concentrate on C4, C7 and the average of
C8-C11

Route
Descr
 FFA Settlement
On settlement,


• if the contract rate <settlement rate,

• Seller of the FFA is required to pay the buyer
settlement sum
• (SR-CR ) X number of days specified in the
contract
•
• Conversely, if the contract rate is greater than the
settlement rate the buyer is required to pay the
seller the settlement sum.
•

 Freight Rate Formation in
the Market
 Spot freight rates are determined through the interaction of
supply and demand for shipping services at any point in
time
The demand for sea transportation is a derived demand,
Demand

which depends on world economic activity and

international trade •Political events
•The world economic activity
•Seaborne commodity trade•Transportation cost
•Average haul

•
•T h e su p p ly o f sh ip p in g se rvice s is th e a m o u n t ( to n -
m ile s) o f tra n sp o rta tio n se rvice o ffe re d b y sh ip
Supply

o w n e rs'fle e t b a se d o n th e o p tim iza tio n o f th e ir

re ve n u e
• •Fleet productivity
•Stock of the fleet •Freight rates
•Shipbuilding production
•Scrapping and losses
 W o rld sca le
 
•New Worldwide Tanker Nominal Freight
Scale (World scale) = annual publication
listing $/MT for voyage between 2 ports.
 
•WS rate -% applied to flat rate to
calculate the $/MT rate for specific
voyage between 2 ports.
 
Flat Rate x WS Rate = $/tonne rate
eg 5.40 x W150/100 = $8.10/MT
 TD3 -Example Trade
•
• •Buyer /Seller-We Buy
• •Route-TD3
• •Period-Q4 07
• •Quantity-20kt
• •Contract price-WS88
• •WS Flat Rate-17.72
• •Contract-FFABA / ISDA / Cleared
• •Counterparty-OTC -Counterparty Risk
•
 TD3 Example Trade

•
•Q4 07 has three monthly settlements.
•October: WS57, November: WS91, December: WS240

•P/L Calculation for October =

Settlement Price -Contract Price x Flat Rate x Size of

Trade
•
(57%-88%)x17.72x 20,000 =(31%)x354,400
October Loss = ($110,000)

• Similarly
November Profit = $10,000

December Profit = $540,000

 TD3 Trade Example


Conclusion


• Our Trade has generated a profit of roughly

$440,000.
• If we were using the trade to cover physical
exposure then this would be available to
offset our increased freight costs in Q4.
– A full 260,000mt trade would have
generated $5,720,000
• By hedging we are able to fix our future
costs according to known FFA pricing .
• The decision not to hedge leaves unknown
risk exposure.
• FFAs can effectively manage freight risk.
 TD3 Options
•
• You buy a Call Option (The right to
buy)
• Q4 ‘08 W120 Call -Cost W10
• Result.
• If the market goes above W120 in Q4
‘08 you have all the profit, once
your cost of W10 is covered.
• If the market falls you only lose 10
Worldscale points.
 Uses of FFAs
H e d g in g
Cargo owners (power utilities, oil companies)
are buyers of FFAs
Market information
Forward curves
Speculation
FFAs give the possibility to profit from
falling
freight markets
Enhanced trading opportunities
Arbitrage trades (e.g. API2 vs API4)
Spread trades (TD3 vs TD5, Cape vs Panamax)
Collateral in ship finance transactions
 Uses of FFAs: Forward
Curves


• Forward curve is a ’snapshot’ of current

market
 forward price expectations.
• An implied market forecast – based on all
market
 participants
• A method of comparing FFA opportunities
against
 physical options.
• Used for position and portfolio valuations.
 Uses of FFAs: Trading
Opportunities
• Good liquidity in FFAs – position tradability-
‘buy’ and ‘sell’
• High volatility – position taking opportunities
• More trading players than physical
– Investment banks, trading houses, hedge funds
• Spread Trades
– Inter route spread, e.g. C4 v C7, TD3 v TD5
– Inter month spread, e.g. 3rd Q06 v 4th Q06
– Inter-size spread, e.g. P-4TC v C-4TC

 Risks
 Credit Risk (Netting Facility by exchange)
 Volatility of market
 Unpredictability due to time horizon
 Hedging and speculation
 Basis risk
 Liquidity risk
- Overall, less risky than physical market
•
 Dealing with Credit Risk
• Trading cleared contracts
– IMAREX with NOS in Oslo offer cleared FFAs
and Options
– London Clearing House, NYMEX and
Singapore Exchange also provide clearing
services
• Cleared FFAs provide protection against
counterparty default, however
– Margin requirement and initial deposits tie-
up a lot of capital
– Margining and marking to market may
create a cash-flow mismatch between the
paper and physical markets
 FFAs – Future Trends
• The market has grown sharply following deregulation
and liberalisation in the European Energy market as
energy and other traders seek to manage freight
risk


• Recent high volatility in the market has also attracted

interest from investors outside shipping such as
hedge funds


• Credit Risk and Clearing

– Clearing will also attract new players in the markets
as it also facilitates and speeds up negotiations
–
• Electronic Trading


• Emergence of Freight Options

Freight Derivatives in INDIA
• MCX in strategic collaboration with the Baltic
Exchange proposed to introduce freight
futures contract in year 2004
•
• Cargoes at Indian ports are expected to top 1
billion tonne in 2011 compared to about 845
million tonne last year. So huge potential for
freight derivative market.
•
• MCX would create India-specific freight
contracts keeping into consideration India's
large coastline consisting of ndia's large
coastline of 11 major and 139 minor ports
•
Thank you