A Panamax owner is concerned that freight rates will fall in Q2 (April, May, and June) 2022

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Question:

A Panamax owner is concerned that freight rates will fall in Q2 (April, May, and June) 2022 and he wants to lock in his profits from the high market. His required breakeven freight rate is $ 11,500/day, whereas the market is trading at a large premium. He has several options:

Do nothing and risk the market changing.

Enter a time charter, but this would lose his interaction with the spot market and is inflexible if other opportunities arise.

Sell an FFA (freight forward agreement) to lock in his rate but keep control of his vessel.

The Cal Q2 2022 market BPI avg is bid (buyers) $15,000/day and offered (sellers) $15,500/day. The owner decided to sell Cal Q2 2022 at $15,000/day.

This settles monthly against the index averages each month.

a) Explain how the owner locks in his profit from selling an FFA by drawing a diagram with the appropriate curves to present long/short FFA, vessel breakeven, and locked-in profit/loss.

b) Assume that the settlements in April, May and June are $13,500/day, $15,000/day and $17,500/day, respectively. Calculate the total profit/loss gained by the owner by selling this FFA.

c) Elucidate on the following terms which are associated with DERIVATIVES. You can make use of a scenario to assist in clarifying your answer. i. An “Underlying”, ii. A “Cap” and a “Floor”.