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The Shipping Corporate Risk Trade-Off Hypothesis

The decision making process in maritime financial management consists of three main pillars: investment, financing and operation. Each pillar defines its own sub-universe and constitutes its own market with its own rules. The investment pillar refers to the market for newly built and secondhand vessels, the financing pillar is associated with the markets for debt and equity capital, and the operation pillar is related primarily to the freight market. Nevertheless, all three pillars and their underlying markets have one common denominator, namely “volatility”, which affects – in various ways and through various channels – the level and the variation of the outcome of any shipping corporate decision. Specifically, given that vessel prices can move radically in either direction, the decision of when to invest in a newly built or a secondhand vessel exposes shipping companies to substantial investment risk. Management’s choice to operate a vessel in the spot charter market rather than in the period charter market introduces market risk due to the variation of freight rates as a result of shipping market demand and supply shifts. And, finally, the choice between debt and equity financing determines a shipping company’s financial risk, as increased financial leverage reduces the probability that the cash flow generated from operating a vessel will be sufficient to meet the contractual capital repayments and the associated interest expense.

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Written by: | Categories: Marine Money | October 1st, 2011 |

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