Ilias D. Visvikis

Shipping Freight Derivatives: A Survey of Recent Evidence

In an industry that is characterized by highly volatile prices, seasonality, strong business cycles, cyclicality and capital intensiveness, risk management is extremely important. Ship-owners and charterers face enormous risks, which emanate from fluctuations in freight rates, bunker prices, interest rates, foreign exchange rates and vessel values. These risks substantially affect the interplay between revenue and cost. Modern risk management techniques, involve the use of financial derivatives products, some of which have been developed exclusively for protecting (hedging) against the adverse price fluctuations of the aforementioned sources of risk in shipping. By using derivatives products, ship-owners and charterers can secure (stabilize) the level of their future income or costs and thus reduce uncertainty and unforeseen volatility of their cash-flow. To explore the importance of hedging freight rate risk in shipping operations, a survey of recent empirical evidence that has appeared in economic studies has been conducted. Developments over the past 20 years have been fast, with certain amount of research carried, which has helped to understand better the special features of these derivatives markets. They are all summarized in the current study, which can provide the stepping stone for further work in the area of shipping derivatives and risk management in shipping.

The Lead-Lag Relationship between Cash and Stock Index Futures in a New Market

This paper investigates the lead-lag relationship in daily returns and volatilities between price movements of the FTSE/ATHEX-20 and FTSE/ATHEX Mid-40 stock index futures and the underlying cash indices in the relatively new futures market of Greece. Empirical results show that there is a bi-directional relationship between cash and futures prices. However, futures lead the cash index returns, by responding more rapidly to economic events than stock prices. This speed is much higher in the more liquid FTSE/ATHEX-20 market. Moreover, results indicate that futures volatilities spill information over to the corresponding cash market volatilities in both investigated futures markets, but volatilities in the cash markets have no effect on the volatilities of futures markets. Overall, it seems that new market information is disseminated faster in the futures market compared to the stock market. This implies that the futures markets can be used as price discovery vehicles, providing further evidence that derivatives markets contribute to completing and stabilising capital markets in Greece. A further finding of this study is that futures volume and disequilibrium effects between cash and futures prices are important variables in the explanation of volatilities in cash and futures markets.

Hedging effectiveness of the Athens stock index futures contracts

This paper examines the hedging effectiveness of the FTSE/ATHEX-20 and FTSE/ATHEX Mid-40 stock index futures contracts in the relatively new and fairly unresearched futures market of Greece. Both in-sample and out-of-sample hedging performances using weekly and daily data are examined, considering both constant and time-varying hedge ratios. Results indicate that time-varying hedging strategies provide incremental risk-reduction benefits in-sample, but under-perform simple constant hedging strategies out-of-sample. Moreover, futures contracts serve effectively their risk management role and compare favourably with results in other international stock index futures markets. Estimation of investor utility functions and corresponding optimal utility maximising hedge ratios yields similar results, in terms of model selection. For the FTSE/ATHEX Mid-40 contracts we identify the existence of speculative components, which lead to utility-maximising hedge ratios, that are different to the minimum variance hedge ratio solutions.

The hedging performance of the Capesize forward freight market

Within the context of risk management in the shipping finance sector, the focus of this paper is the calculation of the optimal number of forward freight agreements (FFAs) for hedging a given level of exposure. The authors assess potential alternative strategies, taking into account the specific properties of both spot and FFA prices in the Capesize sector, by analysing a variety of models that are used to empirically estimate optimal hedges and comparing various factors. These factors are as follows: (i) the hedging effectiveness of dynamic (time-varying) and constant hedge ratios; and (ii) whether in-sample or out-of-sample hedging horizons are relevant and appropriate for investors who wish to manage their freight rate risk in the Capesize sector through participation in the derivatives markets. The results are beneficial in that they show that players in the Capesize market may more easily develop more appropriate hedge ratios and, thus, manage freight rate risk more efficiently and effectively.

A Financial Business Case for Corporate Social Responsibility

The shipping industry facilitates substantially the operation of a global supply network and plays a pivotal role in the global transport of products. Shipping positively affects the lives of billions of people, with 90% of the world’s international trade travelling by sea. The challenges of the sector are multiple due to the cyclical nature of the industry, the global political and economic instability, the bulk volume of environmental laws and the volatility of bunker fuel and freight rates. The international nature of the industry possesses significant challenges because regulations are usually taken in a global level and enforced on the local level in which there are various environmental and national peculiarities.

Managing Financial Resources in Shipping

An important characteristic and key feature of the shipping industry is that it is highly cyclical; this cyclicality is particularly apparent in the traditional, less specialized and highly fragmented dry bulk and tanker shipping sectors. Freight rates follow a volatile pattern, due to changes in the industry’s underlying demand and supply forces. As can be observed in Fig. 7.1, volatility of freight rates has a direct effect on shipping assets whose value follows a cyclical pattern similar to that of freight rates. Another important characteristic and key feature of the shipping industry is that it is highly capital intensive. The acquisition, ownership, and management of shipping assets require the commitment of very large amounts of capital. The establishment of a meaningful presence (critical mass) in shipping will typically involve the formation of a fleet of at least 7–10 vessels, and depending on the specific shipping sector, this will require a significant investment amount; e.g., the acquisition of a 5-year old Capesize vessel would require in September 2016 the commitment of about

Maritime Business Freight Risk Management

24 million. As a result of the industry’s cyclical and capital-intensive nature, it is fundamental for the industry’s participants and capital providers to determine if the timing is appropriate for investments in shipping. Furthermore, and in order to ensure the viability of shipping investments, it is equally important to develop an understanding on the different financial sources of capital that are available in the industry and the techniques and strategies that can be employed to manage business risks. This chapter aims to expose the reader to the different sources of shipping finance, analyze each of them, and provide an overview of the present challenges in the sector. A deeper understanding of these ship-financing sources and conditions will assist toward employing these and developing the best possible capital structure for a shipping project and a company as a whole.

Market interactions in returns and volatilities between spot and forward shipping freight markets

Due to the volatile nature of the shipping industry in rates and prices, market practitioners attempt to minimize the impact of adverse price movements of freight rates, bunker fuel prices, interest rates and foreign exchange rates, among others, through the use of financial derivatives products.1 This risk management process has enabled companies operating in the industry to stabilize cash flows (revenues and costs), have more effective budgets, secure their shipping loans, and protect their corporate firm values. This chapter presents an overview of the various derivatives products and markets available to hedge the most important source of risk in the industry—namely, the freight rate risk—and to provide the trade specifics, uses and changes in regulations of freight rate derivatives.2