What Is a Forward Freight Agreement?

A forward freight agreement (FFA) is a type of contract that provides the opportunity for investors and others to hedge against the movement of freight rates within the marketplace. This approach makes it possible for owners of ships that actually convey the freight to have some sort of protection from rate increases and decreases that may occur due to movements in the marketplace, as well as allow professionals who charter those ships for freight deliveries to also protect their investment in the effort. Even outside investors can benefit from this type of hedge, possibly generating returns based on what occurs with freight rates over the life of the agreement.

The terms of a forward freight agreement allow the owner of the agreement to engage in transactions that have to do with the price of the freight on dates that will occur over the life of the contract. In order to set the terms, a number of factors are taken into consideration, including the trade route used to deliver the freight in question, the nature of the freight itself, and even some allowances for events that are outside the control of the shipper, such as acts of nature. Typically, the terms will include provisions that allow the owner to benefit when certain types of events take place, while also minimizing the potential for losses if other events should occur.

A forward freight agreement is often traded over the counter, meaning that it is not a type of investment that is traded on an exchange of some sort. When choosing to purchase this type of investment, the process will often require working through a clearing house to manage the purchase or sale of the contract. This means that the buyer or seller, and possibly a combination of the two, will incur some type of transaction costs, notably broker fees as well as clearing fees.

Like any type of investment, there is some degree of risk with a forward freight agreement. Before choosing to invest in this type of contract, care should be taken to research the freight involved in the contract, the potential benefits involved with the hedge, and the likelihood of some adverse circumstances occurring that would trigger a loss on the investment. While there is some risk involved with any forward freight agreement, it is not unusual for the owner of the contract to enjoy equitable returns in exchange for the purchase of that agreement.