Shipping Derivatives and Risk Management

Cover......Page 1
Contents......Page 6
About the Authors......Page 16
Preface and Acknowledgements......Page 17
Foreword......Page 19
Figures......Page 20
Tables......Page 26
1.1 Introduction......Page 30
1.2 Types of risks facing shipping companies......Page 32
1.3 The risk-management process......Page 35
1.3.1 Why should firms manage risks?......Page 36
1.4 Introduction to derivatives: contracts and applications......Page 37
1.4.1 Forward contracts......Page 38
1.4.2 Futures contracts......Page 39
1.4.4 Options......Page 41
1.5.1 Risk management......Page 42
1.5.3 Arbitrageurs......Page 43
1.5.4 The price discovery role of derivatives markets......Page 44
1.5.5 Hedging and basis risk......Page 45
1.5.6 Theoretical models of futures prices: the cost-of-carry model......Page 47
1.6 The organisation of this book......Page 49
Appendix 1.A: derivation of minimum variance hedge ratio......Page 52
2.2 The world shipping industry......Page 53
2.3 Market segmentation in the shipping industry......Page 57
2.3.1 The container shipping market......Page 59
2.3.2 The dry-bulk market......Page 60
2.3.3 The tanker market......Page 63
2.4 Shipping freight contracts......Page 64
2.4.1 Voyage charter contracts......Page 66
2.4.2 Contracts of affreightment......Page 68
2.4.3 Trip-charter contracts......Page 69
2.4.5 Bare-boat or demise charter contracts......Page 70
2.5.1 Capital costs......Page 71
2.5.3 Voyage costs......Page 72
2.6 Spot freight-fate formation......Page 73
2.7 Time-charter rate formation......Page 77
2.7.1 Time-charter equivalent of spot rates (TCE)......Page 80
2.8 Seasonal behaviour of freight rates......Page 81
2.9.1 Factors determining ship prices......Page 84
2.9.2 The newbuilding market......Page 85
2.9.3 The second-hand market......Page 87
2.9.4 The scrap or demolition market......Page 89
2.10 Summary and conclusions......Page 92
3.2 Data sources and data-collection methods......Page 94
3.3.1 Measures of central tendency (location)......Page 96
3.3.3 The range......Page 98
3.3.4 Variance and standard deviation......Page 99
3.3.5 Coefficient of skewness......Page 102
3.3.6 Coefficient of kurtosis......Page 103
3.3.7 Coefficient of variation......Page 104
3.3.8 Covariance and correlation......Page 106
3.3.9 Comparison of risk across different vessel size and contracts......Page 107
3.4 Time-varying volatility models......Page 109
3.4.1 Rolling-window or moving-average variance......Page 111
3.4.2 Exponentially weighted average variance (EWAV)......Page 112
3.4.3 Realised volatility models......Page 113
3.5.1 The theory of ARCH models......Page 114
3.5.2 Asymmetric GARCH models......Page 117
3.5.4 Exponential GARCH model......Page 119
3.5.5 Markov regime-switching GARCH models......Page 123
3.5.6 The term structure of forward-curve and freight-rate volatility......Page 126
3.5.7 Stochastic volatility models......Page 128
3.5.8 Multivariate GARCH models......Page 129
3.6.1 Historical volatility forecast......Page 131
3.6.3 GARCH models......Page 132
3.7 Summary and conclusions......Page 135
4.1 Introduction......Page 136
4.2.1 Baltic Capesize Index (BCI)......Page 137
4.2.2 Baltic Panamax Index (BPI)......Page 139
4.2.4 Baltic Handysize Index (BHSI)......Page 140
4.2.5 Baltic Dry Index (BDI)......Page 141
4.2.6 Baltic Clean Tanker Index (BCTI)......Page 142
4.2.7 Baltic Dirty Tanker Index (BDTI)......Page 144
4.2.8 Other indices......Page 146
4.3 Calculation of the Baltic Indices and the role of the panellists......Page 147
4.3.2 Calculation of the Baltic Indices......Page 149
4.4 The freight-futures market – historical developments......Page 150
4.5 Summary and conclusions......Page 152
5.2 What is a forward freight agreement (FFA)?......Page 154
5.2.1 Volume by sector and trade......Page 156
5.3 How are forward freight agreements traded?......Page 160
5.3.1 Trading FFAs in the OTC market......Page 162
5.3.2 Contract documentation in the OTC market......Page 163
5.3.3 Credit risk and clearing......Page 166
5.3.4 Trading via a 'hybrid' exchange......Page 174
5.4 Hedging using forward freight agreements......Page 176
5.4.1 Hedging trip-charter freight-rate risk......Page 177
5.4.2 Hedging using voyage FFAs......Page 178
5.4.3 Time-charter hedge......Page 181
5.4.5 Hedge-ratio calculation for tanker FFAs......Page 186
5.5.1 Settlement risk......Page 187
5.5.2 Basis risk......Page 189
5.6 Uses of forward freight agreements......Page 193
5.7 Price discovery and forward curves......Page 195
5.7.1 Baltic Forward Assessments (BFA)......Page 198
5.8 Summary and conclusions......Page 202
Appendix 5.A: FFABA 2007© Forward Freight Agreement contract......Page 203
6.2 Technical analysis......Page 210
6.2.1 Chart analysis......Page 211
6.4.1 Moving average crossover trading rule......Page 215
6.4.2 Stochastic oscillators......Page 218
6.5 Filter rules......Page 221
6.5.1 Moving average envelopes......Page 222
6.5.2 Bollinger Bands......Page 223
6.6 The momentum trading model......Page 226
6.7 Spread trading in FFA markets......Page 228
6.7.1 Tanker spread trading......Page 230
6.7.2 Dry-bulk spread trading......Page 232
6.8 Time-charter and implied forward rates......Page 236
6.9 Technical trading rules and shipping investment......Page 240
6.10 Summary and conclusions......Page 244
7.2 A primer on options......Page 246
7.3.1 Boundary conditions for European call prices......Page 251
7.3.3 Put-call parity......Page 253
7.3.4 Factors affecting the value of call and put options......Page 254
7.4 Practicalities of trading options in the freight market......Page 255
7.5 Risk-management strategies using options......Page 256
7.5.1 An example of hedging using options......Page 260
7.5.2 Hedging using a collar......Page 261
7.6.1 Bull spreads......Page 265
7.6.2 Bear spreads......Page 269
7.6.3 Ratio spreads......Page 270
7.6.4 Box spread......Page 272
7.6.5 Straddle combinations......Page 273
7.6.6 Strangle combinations......Page 274
7.6.7 Strips and straps......Page 276
7.6.8 Butterfly spreads......Page 277
7.7 Summary and conclusions......Page 278
Appendix 7.A: FFABA 2007© Freight Options Contract......Page 279
8.2 Pricing freight options......Page 287
8.2.1 Which approach is better for pricing freight options?......Page 288
8.2.2 The Black-Scholes-Merton (BSM) model (1973)......Page 290
8.2.3 The Black Model (1976)......Page 292
8.2.4 The Turnbull and Wakeman Approximation (1991)......Page 293
8.2.5 Lévy (1997) and Haug et al. (2003) Discrete Asian Approximation......Page 294
8.2.6 Curran's Approximation......Page 295
8.2.7 Applications for freight markets......Page 296
8.2.8 An option-pricing example......Page 298
8.3 Asian options with volatility term structure......Page 300
8.4 Implied volatility......Page 302
8.5 Pricing Asian options using Monte Carlo simulation......Page 305
8.6 Risk management of option positions......Page 310
8.7 Hedging a short-call position: an example......Page 311
8.8 Option-price sensitivities: 'Greeks'......Page 312
8.9 Delta (Δ)......Page 313
8.9.1 Delta hedging......Page 315
8.9.2 Delta hedging of Asian options......Page 319
8.10 Gamma (Γ)......Page 321
8.10.1 Gamma-neutral strategies......Page 323
8.11 Theta (Θ)......Page 324
8.11.1 The relationship between theta, delta and gamma......Page 326
8.12 Vega (Λ)......Page 327
8.13 Rho (Ρ)......Page 328
8.14 Dynamic hedging in practice......Page 329
8.15 Summary and conclusions......Page 331
9.1 Introduction......Page 332
9.2 Simple VaR estimation......Page 334
9.2.1 VaR of multi-asset portfolios......Page 339
9.3.1 Parametric VaR estimation......Page 341
9.3.2 Nonparametric VaR estimation methods......Page 348
9.4 VaR for non-linear instruments......Page 351
9.4.1 Mapping VaR for options......Page 352
9.4.3 Delta-gamma approximation......Page 354
9.5 Principal component analysis and VaR estimation......Page 357
9.6 Backtesting and stresstesting of VaR models......Page 362
9.7 Summary and conclusions......Page 364
Appendix 9.A: Principal component analysis......Page 365
10.1 Introduction......Page 367
10.2 The world bunker market......Page 368
10.3 Bunker-price risk in shipping operations......Page 370
10.5.1 Long hedge using forward bunker contract......Page 372
10.5.2 Short hedge using forward bunker contract......Page 373
10.6 Bunker swap contracts......Page 375
10.6.1 Plain vanilla bunker swap......Page 376
10.7.1 Differential swap......Page 379
10.7.2 Extendable swap......Page 380
10.7.3 Forward bunker swap......Page 381
10.7.4 Participation swap......Page 382
10.8 Hedging bunker price using options......Page 383
10.8.1 Bunker caps and floors......Page 384
10.8.2 Collars or cylinder options......Page 385
10.9 Summary and conclusions......Page 391
11.1 Introduction......Page 392
11.2 Reference rates and international financial markets......Page 393
11.3 Term loans......Page 395
11.3.1 A fixed-rate loan example......Page 396
11.3.2 Floating-rate loans examples......Page 398
11.5 Forward-rate agreements......Page 400
11.6.1 Eurodollar futures contracts......Page 403
11.7 Interest-rate swaps......Page 404
11.7.1 Pricing and unwinding of interest-rate swaps......Page 407
11.8.1 Interest-rate caplets and floorlets......Page 410
11.8.2 Interest-rate caps and floors......Page 413
11.8.3 Interest-rate collars......Page 417
11.9 Pricing caps and floors using Black's model......Page 420
11.10 Forward swaps and swaptions......Page 424
11.11 Hedging using currency swaps......Page 425
11.11.1 Pricing currency swaps......Page 426
11.12 Summary and conclusions......Page 427
12.2 What is credit risk?......Page 428
12.3 What is the source of credit risk in shipping?......Page 429
12.3.1 Qualitative vs. quantitative credit-risk analysis......Page 430
12.4 Credit ratings and rating agencies......Page 431
12.4.1 Shipping high-yield bond issues......Page 433
12.5.1 Extracting default probabilities from traded bonds......Page 436
12.5.2 Historical default probabilities......Page 438
12.5.3 Estimating default probabilities using Merton's model......Page 440
12.6 Credit-risk management and credit derivatives......Page 443
12.6.2 Downgrade triggers......Page 444
12.6.4 Diversification......Page 445
12.6.5 Credit derivatives......Page 446
12.7 Summary and conclusions......Page 453
13.1 Introduction......Page 454
13.2 Ship-price formation......Page 455
13.3 Comparison of ship-price risk across sectors......Page 457
13.3.1 Dynamics of volatility of ship prices......Page 459
13.4.1 Portfolio theory and diversification......Page 461
13.4.3 Forward Ship Value Agreements (FoSVA)......Page 468
13.4.4 Forward curves for ship prices......Page 473
13.4.5 Baltic Demolition Index (BDA)......Page 475
13.5 Summary and conclusions......Page 479
14.2 Financial versus real options......Page 480
14.3 Conventional NPV versus real option valuation......Page 481
14.3.1 Valuation of a shipping project......Page 483
14.4.1 Option to abandon/exit......Page 484
14.4.2 Option to expand......Page 486
14.4.3 Option to contract......Page 488
14.4.4 Option to switch......Page 489
14.4.5 Option to lay-up......Page 490
14.4.6 Option to delay (wait)......Page 491
14.5.1 Option to extend a period time-charter contract......Page 492
14.5.2 Option on newbuilding orders......Page 494
14.5.3 Purchase option on a time-charter contract......Page 496
14.5.4 Option on writing-off part of a debt......Page 499
14.6 Pricing real options using simulation......Page 501
14.6.1 Sensitivity analysis and interval estimates......Page 503
14.7 Summary and conclusions......Page 504
Appendix 14.A: The binomial option pricing model (BOPM)......Page 506
References......Page 510
B......Page 519
D......Page 520
F......Page 521
G......Page 522
L......Page 523
O......Page 524
S......Page 525
T......Page 526
V......Page 527
Z......Page 528