Managing Freight Rate Risk Using Freight Derivatives

Over the last two decades, tramp shipping markets have undergone a fundamental transformation. This period is characterised by very high volatility in the level of freight rates as well as the emergence, maturing and corresponding growth in the derivatives market for freight. Freight rate risk is the most important risk since volatility in freight rates has a direct impact on the profitability of a shipping company. In this chapter we introduce and analyse the derivative instruments that are used in the market to control freight rate risk. We describe the structure and trading practices in the forward freight agreement (FFA) market, its use for risk management as well as how to deal and manage basis risk. We also discuss freight options and their use in risk management and speculation.