THE MARITIME CHRONICLES EPISODE 14: BASIC DERIVATIVE STRATEGY [5 MINUTE READ]
SOURCE: WWW.PEXELS.COM
OK so last time we talked about financial derivatives and what they are.
Its like when you bet on the value of something changing. Like you have a contract with someone that if the value of your house falls below 80% of what it is now, they will pay you a certain amount of money. But for that "insurance" you pay them a monthly premium.
Let's look at an example
Let's say you have a 8 000 TEU container vessel. that you paid 100 million Euro for. Let's say you invested 15 million Euro of your own money into this ship. And you borrowed the other 85% from a bank. Let's say the interest rate on the 85 million Euro loan is 2.5% over a 20-year repayment period. So you would have to pay the bank 450 420 Euro per month. Also, lets say the current freight rates for a route that demands this kind of vessel is 30 000 dollars per day, or approximately 20 000 Euro per day.
SO, IN SUMMARY:
Cost of the Vessel: € 100 000.000
Value of Own Capital: € 15 000.000
Value of the Bank Loan: € 85 000.000
Bank Interest Rate: 2.5%
Bank Loan Repayment Period: 20 Years
Monthly Repayment Amount: € 450 420
Current Freight Rate: € 20 000 per day
Ship Management Fees and Other Costs: € 3 000 per day
Option to lease at € 15.000 (per day): € 500
Now lets say you're pretty good at shipping and you forecast that freight rates for this type of vessel will be about € 10 000 one year from now. How can you benefit from the use of derivatives?
Let's say the market (most people, or the people representing most of the money in the market) thinks that freight rates will fall to about € 15 000 per day during that period of time. You will want to buy a put option on freight rates with a strike price of € 15 000. This means that one year from now, you can sell a certain number of ship rental days at € 15 000 per day, even though the market price at the time will probably be only € 10 000 per day. You will not need to pay that much for this option, because it is the expected price. Assuming the cost of the actual option is € 250 each (per day), you will be making a profit of €4 750 for each day that you have an option for.
If you think that the market downturn will last for 6 months and the average freight rate during this time will be € 10 000 per day, you can make a profit of € 798 000 (28 days X 6 months X € 4 750 per day) assuming that your ship is in use for an average of only 28 days per month (you need to repair and maintain it some days). If you do this, you will be making money while your competitors are defaulting on their loans and going bankrupt.
Hey you can even buy their ships for next to nothing because the banks won't want them - they wouldn't know what to do with them. I'm assuming of course that your costs go down by the same amount as the freight rates. If not, you will simply be saving that amount compared to the case where you didn't buy the option. Which would help you survive until the market turmoil is over.
SOURCE: Swart, Petrus, 2007. Masters Dissertation. Hamburg School of Logistics.
Savings Possibilities by using Options under different Scenarios
The savings per month by using an option here is € 126 000. This result shows that by buying and exercising the option you as the shipowner can earn an additional monthly profit, or save a monthly amount, of € 126.000.
Even at the initiation phase of a shipping project, however, derivatives are helpful. Like at the point in time when you apply for a loan at a bank for the capital needed to purchase a vessel. If you show them that you know how to use options, they will like you more. Why? Because they see that you are planning to use hedging tools in the form of derivatives to ensure steady cash flows.
The fine print
Please note that this example does not take into account the resale value of the vessel or any possible revenue resulting from ship operations after the 20-year bank repayment period. It may appear rather gloomy for the shipowner as only cash flow is presented.
References:
Swart, Petrus, 2007. Masters Dissertation. Hamburg School of Logistics.
Tzavaras 2007. Interview by e-mail in 2007.
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Very well put logistic post... not bad for a translator...
:D
HEY DON'T DISS TRANSLATORS! LOL!
LOL
Have a great day see you on 9 Sep
:D
The shipping business looks very profitable. But you need to know what you are doing right? Not anyone can just step into it?
Good question. I have no idea to be honest. But if it is like anything it used to be about 50 to 100 years ago, all you really need is good connections. Back then I don't think it mattered how much expertise you had. Aristotle Onassis I think is a good example. He was a tobacco guy, who just saw that he could make more money shipping the stuff than just making it.
So he bought some cheap ships via a deal with the US govt. He sold them equipment for old ships and then he used those old military ships to transport tobacco. And then because he made so much money he just kept buying and buying ships.
But I think networks are still crucial because of insurance. Insurers usually can't insure these vessels because the financial loss in the event of a ship sinking is just too big. They can get insurance for hull/machinery damage or for cargo loss, but not for major events like the ship sinking. Such events mean financial losses of hundreds of millions, and even billions, of dollars. Especially for LNG or PNG ships. Liquified Natural Gas or Petroleum Gas ship prices can literally reach up to a billion dollars each. It would be relatively easy for someone to take out a ship to get the insurance money directly or indirectly.
So what the shipping industry does is they have what they call P&I clubs. Yes you heard right, CLUB! P&I stands for Protection and Indemnity Club. So these are groups of shipowners who join together like in a medical scheme / health insurance. They have a kitty that they all contribute to that would cover some adverse event. If nothing happens, the next year the contribute a little less. If something big happens like an oil spill or a ship sinks, they all contribute more next year.
Sounds pretty primitive, but that is how it works. It works by the principle of General Averages, which was developed by the Ancient Greeks. No wonder the Greeks are so good at shipping. Onassis was Greek.
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good question.......
yeah what do you think @mlsivaganesh?
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Thanks!
where are you my friend i miss you
Why?
because i did not see you comment of my post
O no which one?
Nice piece. You've piqued my interest towards the area of maritime.
Thanks, I appreciate those kind words. I hope you have a wonderful day. Anything in particular that you liked?
I like the analysis you gave. It's well simplified. I hope it will be as easy as this in practice?
You've got what it takes.