What is a swap and how does it work on a technical level?

A swap is an instrument to cover any exposure in the future by swapping a floating price i.e. unknown price with a fixed price for a specified future period.

What is a hedge?

A hedge is a protection on a future risk.

What mechanisms are behind hedging and how you minimize risks by using it?

There is a large market for relatively standardized products with a wide range of participants trading to offset opposite risks.

A simple example is a supplier of fuel on one side and a shipping line on the other side. The supplier has purchased a cargo of fuel that he intends to sell over the coming three months however his purchase price is known now but his selling prices are subject to market price. The shipping line have entered a contract to move cargo for the coming three months, so their income is known but their fuel price is subject to market prices. The supplier and shipping line can offset the risks of each other if they can agree on a future price.

This is obviously an over simplified description, but it is what happens in the market where millions of trades are offsetting risks for a lot of different market participants. Various trading houses and banks are offering a marketplace for all these parties to trade their risks.

How does months average work compare to DOD/DON. What’s the difference and what’s the benefit of each?

The month average and the DOD/DON are simply different ways of determining the final price. To create a standard market the paper market is trading month average so this is the most liquid and sharp pricing however the DOD/DON offers more flexibility in a shipping market where delays can happen.

What are caps and collars and how do you use them?

These are different option strategies in financial market, options are commonly used to tailor a desired protection strategy where you can remove certain unwanted risks by paying a premium or reducing price by taking on a different risk profile.

How are credit lines calculated for a customer entering an FPA, and what is the difference between the min transfer amount and the agreed credit line for a customer?

There is no formula to calculate the credit line, it depends on the risk the group is willing to take on each client.

The minimum transfer amount is an extra layer to the credit line added to avoid to many collateral transfers.