Effectiveness of forward freight agreements in mitigating handymax bulk ship-owners’ business risks between 2006 and 2015

Shipowners are constantly exposed to risks while operating in a volatile freight market, which determines the ability for shipowners to cover their cost obligations. In order to reduce their risk exposure, shipowners have to employ various risk management tools. Traditional physical hedging tools, such as the Time Charters (TC), have been utilized by shipowners to hedge their earnings in the freight market. Recently, the paper hedging tool, Forward Freight Agreement (FFA), was introduced as an alternative hedging tool to manage freight volatility and mitigate freight-rate risk. This paper aims to evaluate the effectiveness of using FFA as a hedging tool to mitigate shipowners’ business risk in the Handymax dry bulk market, from 2006 to 2015. Firstly, the paper discusses extensively on the various risks faced by a shipowner. A quantitative approach was adopted to create a financial model so as to simulate the cashflow of a shipowner in real life. Using data extracted from Clarksons Shipping Intelligence Network, Moores Stephen OpsCost and Bloomberg, the model simulates the financial performance of a shipowner acquiring Handymax Vessels through various acquisition and deployment methods. In addition, a hedging strategy was developed to simulate hedging by a shipowner. The risk and returns derived from an unhedged position was determined and compared with that of a hedged position across the period of 2006 to 2015. The study found that hedging with FFA did not produce better returns despite risk reduction, as compared to operating in the spot market with no hedging tools employed. The performance of hedging was not consistent and there exist some years where engaging in FFA further eroded the earnings brought by the bullish market, despite generating negative returns. Overall, it is impossible to hedge using 1CAL FFA as it did not help shipowners to mitigate freight risk but worsen the returns generated. This paper serves to identify risks shipowners are exposed to and provides a structured process for shipowner to employ FFA as a risk management tool. The objective of this experiment allows comparisons to be made against other hedging tools and can be replicable under different experimental variables for practical applications in the shipping industry.Bachelor of Science (Maritime Studies