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What are Freight Derivatives?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 28 August 2016
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Freight derivatives are financial products used to trade in freight futures, financial instruments based on making predictions about future prices for freight in various markets. People trading freight derivatives are not actually exchanging contracts to carry freight; they are trading financial products developed by buying and trading estimates about the prices for shipping at some period in the future. Initially developed to allow people in the freight industry to hedge their risks, these products are also used by speculators like hedge funds to generate profits for their clients.

Costs of shipping change all the time in response to market conditions. As supply and demand shift, the cost of moving particular types of freight like dry goods and oil fluctuates. For people in the industry including shippers, suppliers, and warehousing firms, this can create potentially serious risks. Buying futures contracts allows people to lock in a contract price on the basis of a guess about whether freight prices will rise or fall in the future. The contract includes the type of freight, the date, the route, and the rate.

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For speculators, freight derivatives provide numerous opportunities for investor profits. Buying and selling these contracts as the freight market shifts allows people to take advantage of market movements. It also creates more liquidity in the market. Markets for freight futures can be quite volatile, especially in particular sectors like contracts involving particular ports or specific kinds of freight. Taking advantage of that volatility, speculators can ride the market up and down with various well-placed investments in freight derivatives.

Exchange traded futures and forward freight agreements are two examples of freight derivatives. These financial products are traded worldwide in a wide variety of markets, including via electronic means, allowing people to engage in the freight derivative market at any time, including after trading hours have ended in their locations. Information about the direction of the derivatives market is provided in many financial publications, along with real time quotes on websites and broadcast media.

The size of freight derivative products varies widely. Generally, these products are traded by investors working in high volume with big accounts, and are not as popular among smaller investors. Investors in hedge funds can access freight derivatives by pooling investment resources from a group of people and relying on the manager of the fund to make appropriate purchases while representing the interests of the investors in the financial market.

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