Hedging the Commodity Price Risk using Commodity Swaps
A commodity swap is similar to an interest rate swap, but the parties exchange a fixed price for a commodity with a floating, or variable price for another, or the same, commodity.
Commodity swap offers the hedger the opportunity to convert floating price contract to fixed price and vice-versa, hence helping to hedge the commodity price risk.
Before you can enter your commodity swap details as a hedging instrument, there are number of settings you must maintain:
Commodity master data. See also Commodity Master Data.
Commodity curve data. See also Commodity Curve.
Create the commodity swap instrument. See also Commodity Swap.
Define the calculation type in Customizing:
Select Calculation Category as 21 Hypothetical Derivative. See also Hypothetical Derivative.
Select the Create Hypo. Derivative Automatically check box.
Define an Assessment type in Customizing:
Define the hedging strategy:
The Calculation Type and Assessment Type you have defined, should be included in the Hedge Strategy
Before completing this activity, see also Hedge Plan (Hedging Relationship Management).
In the SAP Area menu of the Treasury and Risk Management open
Create a new hedge plan with a Risk Category of Commodity Category Price Risk and save it.
Click the Hedge Plan button.
Enter an unhedged exposure in the hedge plan:
Unit of Measure
Open the Hedge Item tab, create the hedge item and select the hedge category:
Cash Flow Hedge
Fair Value Hedge
Open the Hedging Relationship tab page and create the hedging relationship using the commodity swap created earlier as the hedging instrument.
Select the Hedge Strategy you defined earlier. This includes the hypothetical derivative method.
Hedging with Commodity Swaps – Hypothetical Derivative method
Commodity Swaps can be used as a hedging instrument in both a cash flow hedge and a fair value hedge. The following types of swap can be used as a hedging instrument in the hedging relationship.
Single cash flow at settlement
Multiple cash flows at periodic intervals
For example, commodity exposure of 60,000 tons of a “Commodity A”, priced at LME, for delivery after 6 months.
Hedge with commodity swap (pay floating, receive fixed) with single settlement after 6 months.
Hedge with commodity swap (pay floating, receive fixed) with settlement of 10,000 tons of “Commodity A” every month.
The effectiveness test is run on:
Change in fair value of Hypothetical derivative
Change in fair value of commodity swap
The delta of the NPV of the hypothetical derivative is compared with the delta of the swap to determine the effectiveness ratio.