<p>about your learning experience to help us improve.</p>

You've completed

cleanFiles/bookmap_SAP_Commodity_Management_Solution_for_Oil__en-US_learning-sap-com_lsc-prod.zip (MMCP-DROPZONE) - 2025-03-17T13:06:31.000Z

Understanding Financial Transactions Business Context & Usage

<div id="content"><div class="parentsection"><div class="section"><div class="kalturaVideoLessonWrapper"><div aria-label="" class="kalturaVideoLessonContainer" data-testid="video" id="1_npd3rkf1"></div></div></div></div><div class="parentsection"><div class="section"><div tabindex="0"><h3>Lesson Summary</h3></div><div class="formalblock"><p tabindex="0">In this video you've learned:</p></div><ul style="list-style-type:disc"><li tabindex="0"><strong>Supported Instruments:</strong> Commodity futures, listed options, forwards, swaps, and OTC options are supported for risk management.</li><li tabindex="0"><strong>Futures Trading:</strong> Futures are standardized, exchange-traded contracts with fixed prices and delivery periods, involving brokers and margin management.</li><li tabindex="0"><strong>Options Overview:</strong> Options grant rights to execute trades at expiry, with American and European styles supported; margin management is required.</li><li tabindex="0"><strong>Commodity Forwards:</strong>OTC agreements between parties, allowing for negotiated terms and average pricing windows; can be physically or financially settled.</li><li tabindex="0"><strong>Commodity Swaps:</strong>OTC trades exchanging cash flows between commodities, with customizable terms; always financially settled.</li></ul></div></div></div>

Financial Transactions Business Context and Usage

SAP Commodity Management Solution for Oil & Gas and Metals & Mining

SAPIndustry_Day5_Part1.mp4

Today, we will go through some details on the risk management derivative side. So yesterday, we went through an overview of risk management and how the solution looks like on a very high level on the physical and financial side. Today, we will go down a little bit deeper, focusing on financial side. If you have any questions from yesterday's session, we can address those before we start or you know you can ask them later as well correct so as i said we will the agenda for this session is basically to see what kind of financial instruments are supported and what are the usage and scenarios will be covered through the financial instruments in commodity risk management. All right, okay. So the below instruments are available, right, and supported by commodity risk management solution. Basically, commodity futures, listed options, commodity forwards, commodity swaps, and commodity OTC options. So these are the instruments currently supported, and they provide all the subsequent and end-to-end scenarios associated with them. I mean, just to give you in background, futures are exchange -traded instruments. These are standardized exchange -stated instruments. So the common nomenclature we use are either buys or sales or long or short, you know, and you buy a particular commodity based on their lot sizes, futures and options are always bought, not per barrel, but based on their lots at a fixed price and at a certain future date. And this future date basically means if you recollect the session based on the DCSIDs or derivative contract specifications. So we have delivery period. So this future date is in reference to that delivery period. So basically there can be multiple parties involved. Like for example, you as a trader for your organization can execute a future and there will be a broker involved or, you know, and then exchange involved. So this broker is basically a clearing broker and who executes the trades on your behalf or he fills your trades. and you know then the position is transferred to your books so and these are pretty standard contract terms it's it's not an over-the-counter trade so there there's no rooms for there is no as such negotiations done and you also have to pay a certain amount of fees associated with each trade and then the trades are basically then transferred to your books via your clearing broker. A few examples of your clearing brokers could be your Citibank, JPM. So there are multiple brokers operating in the market. So, you know, based on whoever gives you a lucrative deal on your costs, secondary costs, basically that's how usually companies opt for clearing brokers. So the price of the future is basically determined by the exchange when it is traded. and that's how you execute a particular trade based on the contract specification. So going into some more details on the standard nomenclatures, so every future which is traded on an exchange follows basically these month convention. So whenever you say, let's say, If, and every future, every commodity has a product symbol. So, for example, at G is a product symbol for copper. And again, every month has a delivery code and followed by year. So if you see on the exchange, it says at GF20. So that means that the edge is a copper future. G is the February contract and year delivery period. So January 2020 is a delivery period or expiry of that particular contract. So that is how general nomenclature is, you know, you would see on any exchange listed product. This applies for both futures and options. And as I was saying, futures are always traded based on their contract size. So in this case, contract size is 25,000 pounds. So that means one lot is 25,000 pounds. So if your trade is 10 lots, so that means when it translates in your position report, lots is 10 lots. But the quantity, as such, the base quality would be 250,000 pounds. So as I was saying, whenever you buy a particular transaction, it's a long position. Whenever you sell it, it's a short position. It's pretty much similar to if you guys, you know, in line with the stock markets as well. So whenever you buy, it's an open position for you. And at the maturity, futures are always held till maturity. and unlike options, you cannot close them before pre-close them before their expiries. It doesn't make sense. And so, and then at the maturity, you basically close or, you know, if it's a buy position, you basically sell it off. If it was a short position, you know, you buy back. So, and then based on the closing trade, you would determine what's the gain and loss you have incurred on that particular trade. All right. So every future, since an exchange is always involved, a clearinghouse is involved, every future has a margin associated with it. So it is like a safe kind of a, in very simple terms, it's kind of a deposit. Every trader or every organization has to pay, so just so that the exchange make sure that they don't incur losses if you run out of money, right? So it's like a default, I mean, safeguard against in an event if an organization default. So every time, whenever you have executes a certain amount of trades, you always have to go through an initial futures margin, which is required to open or a long position, whatever kind of trade you do. Basically, that is the initial margin you have to put down. And then there is margin maintenance every day, which means based on the current market value of a particular trade or a future option. and whether it is in gain or loss, the amounts will be, you know, adjusted accordingly. So if it is in gain, so you would see additional the amount on top of the initial margin in your account, and if it was a loss, then those funds will be adjusted accordingly. So that's how the margin calls are basically used based on each day's market price, settlement price, that is. And at the end of, and when the future is basically nearing its expiry or at the day of expiry, these margin calls are again, then it's called, it moves into a closed margin. So based on, again, gain or loss, you would actually receive or, you know, have to pay out the money based on whatever is your position value at that day. So again, a settlement day basically is the day of the expiry. so there are two ways of doing that you can do a physical settlement or a physical delivery or you can do cash settlement right so a physical delivery is as such that if you have bought a future with 10 lots or let's say in this case it was 20 £250,000 so that means a physical delivery will translates into getting the actual delivery of your product whereas the cash settlement is basically, you know, just the difference between the market price and the contract price times your position and you get that difference. If you are gained, you would receive that amount if it was a loss, you end up paying. So that is, those are the two options. And based on your, since all these futures are most likely hedges against your physical exposure. So you would decide based on the contract terms or what kind of hedge this is based on the exposure, you would decide whether you would want to take a delivery of this future or just a cash offset so that to mitigate your risk when the physical product is actually getting delivered or sold. Next is listed options. So option as such is just a just, I mean, it's another derivative like future. It's, again, a standardized product. And the underlying is, in this case, usually exchange-dated futures. And similar to futures, you also have margin management required, like initial margin or daily variation margins, so that, you know, the potential losses are covered by the exchange in an event of default. So some basic understanding of options, basically it grants, option buyers to write to execute when the option is in the money. So there are various events in an optionalize cycle, in the money, add the money, and based on that, it can be exercised. or some of the options can be exercised only at the expiry. And I think, if I'm not wrong, European options can be only exercised at the expiry and American, you can basically pre-close the option positions as well. So, as I was saying, there are three types of options, American, European or Asian styles. So the complexity varies among these three types of options. SAP supports completely American and European. And I believe the Asian-style options are in scope for the next release of S-4. So the next instrument is Kamari forwards. This is not an exchange-traded instrument. This is an OTC or over-the-counter. instruments. So again, this is a generic term used all over the industry. It's an agreement between two parties. Basically, these two parties can be anyone, me as a buyer, and there could be a bank involved or a broker involved, or any financial institution as such. And at a fixed, you know, a future date, a specific quantity is executed and for a forward price. The concept is similar to if you have understanding on the FX -related trades, right, FX spots or FX settlement, so it's pretty much same. The difference here specifically for commodity forwards is SAP also has our supposed average price commodity forwards. So the commodity forward, you don't basically agree to a specific forward price always, but you do also have an option if that's the term of the contract. the final price could be an average of a particular month or a delivery period or a pricing window. So that's how these instruments work and these are, these are again hedging instruments in SIPP risk management. And this is basically, you know, as I was saying, since these are not exchange rated, these can be negotiated or tailored as per the needs of the counterparty and your, of as a buyer. Again, similar to future, these can also be physically delivered or financially settled. So either you can take the delivery of the product or just do the cash settlement at the day of the expiry or when the pricing window is expired. So in these terms for commodity forwards, you know, again, it could be margin management can be applied in any event that if it is you know you have an offset option for a particular future as well i mean if every time when you would do a mark to market on such instruments if based on the market price or the settlement price if there is a gain or a loss you know you can receive or end up being the difference in in the price or the total amount and you know these can be settled based on that. So it's pretty much the whole scenario, end-to-end scenario based for evaluation and margin controls are pretty similar. It's just that since there is no exchange involved, these are very over-the-counter trades with the counter party. So as I was saying, so commodity forwards are not only as a specific price or a forward price but you can also calculate as average of a price with pricing window right so the pricing window need not be just a complete month or whatever it can be even average of 10 days similar to CPE right where you can decide a price based on a five-day app or a three-day app or a monthly average so something like that can also be achieved on a financial commodity forward trade. So typically what we have seen is it's always like a monthly average since that is the most appropriate price they could get. But in some cases like more complex instruments like a CFT instrument, these could be a weekly average as well, or you know, 10 days average. So that depends on what kind of hedge you are taking and what is your physical exposure underlying physical exposure relates to. So next on we move to commodity soops. Again, this is an over -the-counter instrument meaning the exchange is between two counterparties. So basically you define a period of a time similar to what we have seen in a commodity forward. So you have a pricing window and it could be any pricing window and then the two legs of the swap there will be always two legs in this kind of a trade a buy and a sell side. So you're buying a particular commodity against a particular commodity and basically the cash flows are then exchanged. And these are, again, over-the-counter trades. You can, there are different types of swaps supported by trade and risk management, actually, interest rate swaps, currency swaps, and, you know, for commodity risk management, commodity swaps. So all these swaps are currently, you know, supported in the system. For this session, we will only focus on commodity swaps. And it's similar. The mechanism of a swap is completely similar to what we have seen. So if you guys have experience in treasury and risk management, so like I said, interest rates swaps and currency swaps, it's a similar mechanism. In the commodity swap, basically you have, as I was saying, the two legs of the swap could be your commodity it could be a future uh you can both the future both the legs can consist of a future which then you know settles against the exchange quoted price or it could be a spot price also right so depends on what kind of commodity you're taking or what is your hedge policy or what's your underlying exposure against this particular instrument Again, a commodity, a general explanation is a commodity swap basically is an agreement where you, you know, exchange your cash flows. So you can exchange your floating price against a fixed price or you can even exchange a floating price of a certain commodity with a floating price of a different commodity. or a similar commodity but in a different market so that's that's typically how exchange commodity swaps are done at least what we have seen everywhere there are certain types of commodity swaps though for example a basis commodity swap is basically your exchanging your floating price of a particular commodity with an another floating price with a similar kind of commodity against a different market, or you are exchanging a floating price of a certain commodity with a fixed price of the same commodity. So those are called fixed commodity swap, and depending on how long or short you are on an underlying exposure, the commodity swap determination also varies. So a receiver fixed swap is basically a fixed price is paid. So that means that you are receiving a floating price. And similarly, a payer swap is basically you pay the floating price and you receive a fixed price. So this completely depends on what kind of what is your underlying exposure. And, you know, if your underlying exposure is long, then you, you know, end up receiving a floating price or end up receiving a fixed price so it's all depends on what is this hedge in use for and as I was saying there are basis swaps like you exchange cash flows based on a floating price of a similar or another different commodity in a different market and the advantages here are basically as you as I was saying since these are OTC you can Taylor, basically, like, tailor the terms of the swap, like, you know, what is the pricing window? And, you know, if you can, you know, let go of the exchange or secondary costs or some kind of fees associated with this, this will be based on, you know, how you negotiate with your counterparty. So these are typically the attributes are commodity swaps, and these are all based, settled since this is always an exchange between one cash flow between another there is no physical delivery as such these are always financially settled so we saw earlier OTC exchange options but SAP also supports commodity OTC options and these are not traded on the exchange but you know again these are over -the-counter options and these are primarily floated by banks or other financial instruments. And again, since this is OTC, there is a scope of negotiation between two parties without any intervention of, you know, from an exchange. So the terms and conditions can be completely tailored as per the two parties dealing with this particular instrument. And again, OTC options, I think these are recently introduced in S4. And, you know, similar to an exchange option, this does provide all the attributes and option life cycle, except that the underlying here is always commodity forward. In an exchange option, which we saw previously, the underlying was an exchange listed future, but in this case, the underlying is exchange forward. Sorry, commodity forward. it. And again, the attributes of an option like the strike price, and whether it's a put option or a call option, these all applies for an OTC option as well. So if it is a put option, basically, a put option is basically to sell an option at a fixed price. And basically, the buyer has a right to sell the underlying commodity in this case the underlying commodity being commodity forward um and so sap suppose the complete life cycle of a commodity otc option as well okay so again as i was saying you can enter you know purchases or sales without any issues uh again the same uh it's the same functionality like exercising expiring or change or reverse any kind of transaction uh a life cycle which you would do for other type of instruments applies for this as well. SAP also supports correspondences like if you if you want to do automatic correspondences based on your order trade confirmations and send a notification to your counterparty or receive counter confirmation from your counterparty. So all these functionalities are available and supported in the system. And as I was saying, even the market or valuations for commodity OTC options are supported in the system as well. And since the underlying instrument is forward, OTC forward, commodity forward, you have to have the option to physically exercise or, you know, just settle in cash.