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C. Statistics 
Trade
Payments and Payment Calculations
Thoughts and considerations
for the design of trade payments how they are calculated.
Outline
3) Design Considerations for CTRM
We are talking
about payments on trades, so, for example, for a fixed for float commodity swap
that is one month long, you’ll have two ‘payments’, really one side a payment
and one side a receipt.
Looks like
this. This assumes a volume of 11,000
units (e.g., BBL or GAL or MT or MMBTU) and a fixed price of $51/unit and
assume that market prices are currently $52/unit.
# 
Quantity 
Price 
Payment 
Side Type 
1 
11,000
units 
$51/unit 
$(561,000) 
Fixed 
2 
11,000 units 
$52/unit 
$572,000 
Index/Floating 
Notes:
1.1) There are
two rows, i.e., #1 and #2, to represent two ‘sides’ of the trade. We are paying the fixed price, i.e., so
paying $561,000, so we show it as a negative.
1.2) We are receiving
an estimated $572,000, though this will change as market prices move up and
down until the ‘fixing date’ of the payment.
1.3) The
reality is that both payments would likely be netted (covered by a legal
netting agreement), such the really only one side would pay. If market prices stay as they are, i.e.,
remain at $52/unit, then the counterparty of the trade would pay us $11,000,
which is the sum of the two payments.
You’ll notice
in the above example, the formula for the payment is just price times
quantity. Payment formulas can vary
based on the trade type and commodity.
The problem
is, CTRM system designers will often build into their systems very limited
designs, assuming, for example, that payments will always be based on the
simple price * quantity.
The reason why
this is important, and the reason for this blog post, is that CTRM designers
will often hard code rules about payment formulas by trade type, which is bad.
An interest rate
swap or a loan, for example, will typically have a payment that is calculated
like this:
Notional
amount * interest rate * time in years = payment.
2.1) The
notional amount would be something like $300,000.
2.2) The
interest rate would be something like 2.45%
2.3) And time
in years would be like, 0.5 for 6 months.
The correct value of the ‘time in years’ will depend on Day Count
Convention. See:
https://en.wikipedia.org/wiki/Day_count_convention
For example,
for a day count of ‘30/360’, 6 months will always be 0.5 of a year. For a day count of Actual/360, the number of
days in 6 months could be, for example, 182, which divided by 360 is 0.5055555. So the formula remains notional * interest
rate * time in years and it is just that the ‘time and years’ that will change.
For precious
metals, e.g., gold, silver, platinum, palladium, they will also sometimes have
payments based on an interest rate. Two
parties may agree for a fixed for float swap based on the exchangetraded
futures price as of, for example, December.
Alternately, they may do a swap based on the ‘GOFO’ rate (the gold
forward interest rate). See:
https://en.wikipedia.org/wiki/Gold_leasing
Because some
systems just assume that you can only have a ‘quantity times price’ formula for
commodities, if you want to trade gold based on interest rates, they will often
introduce an unpleasant workaround of modelling gold as if it were a
currency. Because the system design only
allows something setup as a ‘currency’ to be used with interest rate payment
formulas.
Often then,
firms need to setup gold as both a commodity and a currency, which can lead to
different and inconsistent results even in the same system, such as how you
keep track of your inventory of gold when pretending/modelling it as a currency
while tracking other inventory of gold modelled as a commodity.
3) Design Considerations for CTRM
This post
argues a better approach would be to treat all of the payments for any sort of
trade in the system more generically.
For any trade, allow any kind of payment calculation. In other words, on each trade, have a field
where users can select the payment calculation type, e.g., ‘price*quantity’ or
‘interest rate based’.
If a user
selects ‘interest rate based’ for a given payment, that would then open up /
make available other fields that are needed, such as ‘Day Count Convention’.
Other types of
payment calculations include:
3.1) For
options. E.g., for a call option, the
payment formula is the maximum of two items, zero (i.e., $0) or ‘market price
minus strike price times quantity’.
3.2) Tiered
pricing. This would be applicable for
physical deals where the physical volume delivered could be in a range. E.g., you might have the first 8000 units at
a fixed price of $3/unit and then the next 4000 units, so 8001 to 12000 at an
index price based off the NYMEX natural gas last day settle price plus an
spread of $0.05.
It would be
expected to have default values, so users don’t need to worry about the
specifics every time they book a trade.
And the takeaway/lesson is for a new system to design, right from the
beginning, a very generic approach to payment calculations, such that a common
model/design can work for all commodities, physical and financial, interest
rate based and quantity * price based.
Introduction to
CTRM
Click on this
link for a great introduction to CTRM software: Introduction to CTRM Software