Identify and categorize the business risks that are present in the project.

Assignment Brief

Task:

The students need to answer the questions provided in the case study. The case study involves a Shipowner, a Charterer, and a Bank who combine to construct a Special Purpose Vehicle (SPV) for a project. Each student in a group will be assigned as a representative of one of the corresponding parties to complete the project work, so each group constitutes of representatives of (1) Shipowner, (2) Charterer (IG GROUP), (3) Bank, and (4) SPV Operator.

Each student has to identify and analyze the risk exposures for their party separately and  provide risk management strategies for all business risks (including freight rate, bunker price, vessel value, interest rate, foreign exchange rate, and credit risks) associated with them. Your report aims to propose clear and well-argued risk management strategies for the hedging of the various sources of risk that surround the project (ship finance transaction). Your report should be structured into the following sections, for each party separately:

1. Identify and categorize the business risks that are present in the project. You should provide clear and well-documented identification of the sources of business risks in the ship finance transaction. You may also provide support from both the academic and business literature to support your arguments, as well as from the latest advances within the industry.
2. Provide a hierarchy of risk exposures in terms of importance (significance of risk exposure) about the project, with proper justification. You should be able to provide a numerical representation for each risk exposure identified in the previous step, and provide a rationale and a scenario analysis (good, average, worst).
3. Provide all the available hedging methods (both “traditional” and financial) for each source of risk identified in the project. You should first provide an application of all available “traditional” risk management methods and comment on their possible limitation(s) with respect to the specific ship finance project. Then you should present and thoroughly analyze all available alternative derivatives products for hedging each source of risk, and for each party.
4. Select, for each risk, the best available hedging product, according to your justified opinion, and provide a numerical application using the appropriate figures from the project and derivatives prices from the market. All calculations must be analytical and in-depth.
5. You should write a clear and concise list of recommendations supported by appropriate arguments based on the previous risk management analysis in the report.

Notes:

You are free to use any graphs, figures, and tables to support your justifications.

(PLEASE USE GRAPHS,FUGURES,TABLES FROM THE REFERENCES,LITERATURE)

• All calculations must be fully explained and based on the available information.
• All arguments must be critically evaluated based on the latest academic and business literature.
• The use of literature must be fully referenced, and a reference list must be provided  at the end of the assignment.

Extra information:

Front sheet and font (Arial 11 pt. or Times New Roman 12 pt., and 1.5 line spacing, but the List of References should have single line spacing). Use the APA format for referencing. 

• Maximum number of words, excluding the title page, table of content, and list of references

Each Student Word Limits – 3000 words “ONLY THE CHARTERERS PART-IG GROUP” (+ 10 % acceptable).

This assignment needs to be answered carefully by starting from the first quesiton which state to identify and categorize the business risks that are present in the project. You should provide clear and well-documented identification of the sources of business risks in the ship finance transaction. You may also provide support from both the academic and business literature to support your arguments, as well as from the latest advances within the industry.

Sample Answer

Risk Identification and Categorisation for Charterer (IG Group) in a Ship Finance SPV Project

Introduction

In maritime finance transactions, the Charterer plays a critical role, often responsible for securing cargo and ensuring the commercial viability of the shipping project. In this project, involving a Special Purpose Vehicle (SPV) created by the Shipowner, Charterer (IG Group), a Bank, and an SPV Operator, the Charterer faces multiple business risks linked to market conditions, operational factors, and financial exposures. This section identifies and categorises these risks in detail, focusing on the Charterer’s specific risk exposures and drawing upon academic literature and industry best practices to inform the analysis.

Freight Rate Risk

Freight rate risk is among the most significant exposures for the Charterer. As noted by Stopford (2009), freight rates in the shipping industry are highly volatile, influenced by factors such as global trade volume, fleet supply, geopolitical events, and seasonal demand fluctuations. The Charterer, responsible for securing cargo at agreed rates, may face losses if market freight rates rise above the agreed contract price. For example, if a time charter contract is signed at a fixed rate and the spot market rate subsequently falls, the Charterer may pay above-market rates, negatively impacting profitability.

This exposure is particularly relevant in time charter or voyage charter agreements, where the Charterer’s earnings depend directly on freight rate differentials. The Baltic Dry Index (BDI) is often used as a benchmark to monitor freight market movements, and significant fluctuations in the BDI can alter the Charterer’s cost base substantially. Therefore, freight rate risk is a market risk that can materially affect the Charterer’s financial outcomes.

Bunker Price Risk

Charterers are frequently responsible for fuel costs (known as bunkers) under certain charter types such as voyage charters. Bunker fuel prices, like freight rates, are highly volatile, driven by crude oil prices, refinery capacity, and regional supply-demand balances. According to Alizadeh and Nomikos (2011), bunker price fluctuations can significantly impact voyage profitability, particularly on long-haul routes where fuel cost represents a major portion of voyage expenses.

The introduction of IMO 2020 regulations, which mandate the use of low-sulphur fuel oil, has added further complexity and cost variability to bunker pricing. The Charterer must consider this risk, as an unexpected rise in bunker prices can erode profit margins and challenge budgetary forecasts, especially in long-term contractual agreements with fixed freight rates.

Vessel Value Risk

Although vessel value risk is primarily associated with the Shipowner, the Charterer may also be indirectly exposed, especially in long-term charter arrangements involving purchase options, bareboat charters, or in situations where vessel underperformance impacts cargo delivery schedules. For instance, a vessel’s market value decline could affect the SPV’s financial stability, potentially leading to project restructuring or even default. This could in turn disrupt the Charterer’s logistics planning and contractual obligations with cargo clients.

In a long-term commitment, the Charterer’s operational dependence on the vessel heightens this exposure, particularly if vessel depreciation affects its suitability for the intended trade route or cargo type, thereby introducing a commercial risk to the Charterer.

Interest Rate Risk

Although the Bank and SPV bear the principal exposure to interest rate fluctuations, Charterers are affected when higher interest rates result in increased charter hire costs due to debt servicing pressures on the Shipowner or SPV. Rising interest rates may also increase the cost of alternative financing options for the Charterer, especially if they are involved in financing vessel upgrades or operating expenses.

In long-term contracts, interest rate risk can indirectly influence the commercial terms negotiated with the Charterer, as counterparties may seek to adjust rates to reflect higher financing costs. This risk, while indirect, still affects the Charterer’s cost structure and strategic planning, especially in volatile financial markets.

Foreign Exchange Risk

Shipping contracts are often denominated in US dollars, while the Charterer’s revenue or operational expenses may be in other currencies (e.g., GBP or EUR). Foreign exchange rate fluctuations can affect the Charterer’s financial outcomes, especially if revenue from cargo contracts is received in local currency while charter hire is paid in USD.

Currency mismatches can create transactional and translational risks, where adverse currency movements increase the Charterer’s real cost of fulfilling obligations. For example, a weakening of the GBP against the USD would increase the cost of USD-denominated charter payments, reducing profitability.

Hummels (2007) notes that currency risk is particularly acute in international trade, and failure to manage this exposure can have a material impact on a Charterer’s financial performance, especially for those with thin operating margins.

Continued...