| Summary: | The highly fluctuating spot rates in the tanker market inherently results in high volatilities in the earnings of ship-owners. It is therefore crucial to determine whether there is a need to hedge in the tanker market by assessing if the volatile earnings can sufficiently compensate the cost obligations of ship-owners. Should these earnings not adequately compensate the cost obligations of ship-owners, the need for hedging tools is justified. The need for hedging was investigated by analysing the returns and risks of different Asset Classes at varying WACC values. Varying WACC values of 5%, 10%, 15% and 20% used to address the varying levels of risk ship-owners are exposed to.
Traditionally, ship-owners employ physical hedging tools such as Time Charter (TC) to hedge their earnings in the physical market. Time charters, though secured income for the period of hire, did not allow ship-owners to operate in the spot market during the period of hire, hence ship-owners were not able to capture the rising spot rates in a bullish market. Moreover, ship-owners wanted a hedging tool that could better represent their exposure in the physical market. Hence, FFA paper hedge, was an alternative tool for ship-owners to manage their freight-rate risk.
Prior to the employment of FFA, its accuracy as a hedging tool was first investigated. The accuracy of FFAs was determined by its predictive mechanism. Correlation and regression analysis was used to determine the relationship between the forward and final settle prices of each contract period.
Overall, this paper seeks to quantitatively justify why ship-owners need to employ hedging tools. Additionally, prior to determining its hedge effectiveness, the accuracy of FFAs as a hedging tool was investigated. The results were conclusive, and the hypotheses were validated.
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