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Definition: Freight Derivatives
Freight derivatives are financial instruments that are used to reduce the future risk that may arise during a product being in the supply chain. The prices of these instruments are derived from the future rates that shall prevail of any item like dry cargo, oil etc. These instruments are mostly used by the end customers like ship owners or grain ware houses that store food grains in a large quantity. As the volume of the material is high, the price risk that they are exposed to is also higher. Large trading companies and integrated oil companies that act as large suppliers also use this tool to mitigate their risk exposure.
Whenever there are derivative instruments involved, there is a rise to a new vibrant market in which these derivatives are traded as separate commodity. This provides the hedge funds and speculators a a good new liquid market for trading.
Freight derivatives have also moved some of the Over-the-counter (OTC) instruments like swaps futures, Exchange traded futures (ETFs) and the old “Forward Freight agreements” to this new market.
These freight derivatives are relatively new in the market but as the clearing process has generally be smooth and transparent, it has helped the entire market to grow in terms of liquidity, safety and high participation in terms of members.
Delivery dates, exchange rates, volume of material, stage payments are some of the factors that determine the prices. Negotiation for such instruments is generally long and complex due to so many variables and factors to be considered