Dark Energy Consulting
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Detailed Glossary
Detailed Glossary
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Invoicing | ||
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Like most businesses, we sell something, we deliver it, we raise an invoice, we send it to our buyer, we get paid - we hope. The Master Agreement between us and our counterparty will specify if we raise an invoice for a specific delivery (of oil for example), or for a continuously delivered commodity (gas or power for example) over a period (usually a day, week or month) Detail The two main invoicing schedules are:
Invoices usually have the following granularity:
We may therefore raise a number of invoices for a counterparty, with different combinations of the above Once we generate, or raise, an invoice, and are satisfied that it is correct, we transmit the invoice(s) to our counterparty, and we post the invoice(s) into an Account in our General Ledger We expect our counterparty to be doing the same for commodities that we have bought from them, and expect to receive invoice(s) that we will check against our own records To help this we raise a set of shadow invoices, or purchase orders, so that we can compare these to the invoices received from our counterparty. Once agreed we post these purchase orders into an Account in our General Ledger | ||
Netting | ||
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Netting is the aggregating and offsetting of multiple cash flows between counterparties to arrive at one, or a limited set of physical payments Detail There are two distinct sorts of netting: Settlement Netting - which might also be described as payment netting All cash flows between two parties are summed (receipts are positive, debits negative) to arrive at one physical payment due Settlement Netting granularity aggregates cash flows to a single legal entity over one or more cash flow attributes including:
The exact terms of Settlement Netting are described in the bilateral Master Agreement that we have in place with the counterparty Close-out netting - The set of outstanding cash flows that will be netted if our counterparty goes into receivership or liquidation If we are expecting a payment of £999,999 from our counterparty, and they are expecting £1,000,000 from us, and they go into liquidation - we want to be owing them £1, not £1,000,000. The liquidator will do his best for all creditors to try and get us to pay the £1,000,000, and have us wait in line with other creditors for the £999,999. Indeed without a legally sound close out netting agreement in place the liquidator would be favouring us as a creditor were they to let us net the outstanding payments | ||
Exposure | ||
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Exposure is the sensitivity of the value of a trade, or a portfolio, to some market variable A single trade may have Exposure to multiple market variables, and we measure the Exposure to each variable separately. In general there is an Exposure to each independent market variable that determines the value of the trade Detail Consider a simple Physical fixed price Forward delivering in a year's time There is an Exposure to the commodity underlier, let's say a Coal value The Exposure is the shift in value of the trade with each unit shift in the price (or value) of the underlier So a trade to buy 100 tonnes of coal might shift by $1 per tonne, for each shift of $1 per tonne in the price of coal, the 100 tonnes Exposure is 100 100 whats? Let's look at the units. We want the shift in price = 100 tonnes * $1 per tonne = $100, per unit shift in the price of coal = $100 / $1 / tonne = 100 tonnes So the Exposure has units of the underlier! If you've looked at the definition of Delta you will have seen that Delta is properly the change in value per unit of the trade per change in value per unit of the underlier So we get the important formula Exposure = Position * Delta A trade may have multiple deltas and multiple Exposures - our simple Forward deal may not be as simple as we think:
Exposures are additive - they can be summed across a set of trades or portfolios Deltas are not additive - because they are dimensionless ratios | ||
Accrual | ||
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A known future cash flow that has not been invoiced Detail This term is a perfectly standard accounting term. Accruals commence at the time of delivery and continue until an invoice is raised, or an invoice is received For continuously delivered commodities (gas and power), accruals build up over the delivery month, day by day, and continue until an invoice is generated or received early the next month Accruals are posted to the General Ledger, and are reversed out when an invoice is posted Unrealized P&L is not accrued - only delivered (and therefore usually realized) P&L is accrued | ||
APAR | ||
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Accounts Payable/Accounts Receivable Anything relating to these two departments, that is:
Often used to refer to invoices and invoiced cash flows Detail In general the Master Agreement of a trade determines the agreed invoicing cycle and dates A typical invoicing cycle would be to invoice a month's worth of delivery on the 5th day of the following month Our organization must raise invoices, and may raise shadow invoices or purchase orders to match against invoices received from our counterparties Once sent, an invoice cannot be deleted or just ignored, but it can be reversed by issuing a credit note. A credit note reverses part of, or a whole invoice Equally a debit note may be raised to reverse part of, or all of, a shadow invoice or purchase order. This should match a credit note that our counterparty will send to us The set of invoices, shadow invoices and purchase orders, credit notes and debit notes, and the cash flows held in them may be collectively referred to as APAR | ||
Gamma | ||
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Gamma is one of the market risk Greeks It measures the sensitivity of the Delta to an underlier or market value It is of use when the value of the Delta itself varies with the value of the underlier - the Delta being the ratio of the value of the trade or portfolio to the value of an underlier or market value Detail A Physical Forward has a delta of approximately one with respect to the physical underlier, that is the value of a trade increases by 1% for every 1% increase in the underlier By contrast an Option may have a delta of anywhere between -1 and +1, and the delta is not constant At an underlier price of $20/tonne an Option might have a delta of 0.1, but at $40/tonne the delta might be 0.5 Trades with deltas that are constant are called linear (if we were to plot a graph of value against underlier it would be a straight line, the slope is the delta) Trades with deltas that change with the value of an underlier are called non-linear (if we were to plot a graph of value against underlier it would be not be straight - the gamma is the measure of curvature of the plot at a particular point on the graph) As an analogy think of delta as speed, it is the ratio of distance to time. Gamma is acceleration, just knowing the speed of an object doesn't tell us whether it is braking hard, accelerating, or at uniform speed - for that we need the acceleration Because gamma is the change in delta per unit change of price per unit volume of commodity and delta is dimensionless then Gamma has units of 1 / (Price/Volume) = Volume/Price, e.g. Therms/$ Some ETRMs use the term Gamma for the change in Exposure per unit change of price per unit volume of commodity and get Volume / (Price/Volume) = Volume2/Price e.g. MWh2/€ | ||
Greek | ||
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The Greeks are a set of Market Risk measures, using Greek (or Greek-like) letters to measure sensitivities of a trade or portfolio to the set of factors that affect the value of the trade or portfolio Detail For more detail see the individual glossary entries for: If you remember your Greek from school you'll already have spotted that Vega is not a Greek letter at all, just a word beginning with "V" that sounds faintly like a Greek letter | ||
Cash Flow | ||
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A payment that has been, or will need to be paid, on a particular date Detail Every trade creates one or more cash flows, which represent the payments that will be made: For deliveries made - often at periodic intervals (e.g. weekly) For fees, including broker and execution fees, and fees incurred in transportation, storage and inspection of commodities In general the payment date of all cash flows should be known in advance, the amount of the payment may be fixed or based on one or more index, or be calculated form a formula based on a set of observables, underliers, or other factors | ||
Mark to Market | ||
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A way of valuing the unrealized P&L of a simple linear Forward, Futures contract or Swap Detail Most businesses that own assets or hold inventory routinely value those assets and inventory, the change in value between two points in time is the profit or loss Some assets, like computers, simply depreciate, and a simple depreciation percentage is used each year Other assets, like buildings, vary in value with the market conditions, and are generally valued using a mark to market principle (that is we simply look and see what the building is worth at the end of the accounting period) It's important to realize that each trade is an asset (or a liability) - it's a firm contract and must be valued like any other asset The current value of a single trade is the difference between the price paid, and the value of the delivered commodity when it is delivered (which may be a cargo, a day of gas delivery, or a half hour of power delivery) We can find the value of the commodity once it has delivered by looking up the spot trading price on the day of delivery But to value the deal before delivery we must mark the value of the delivered commodity to the market; that is we set the value of the commodity to the price that is currently being paid for the delivery period For example: We have bought 10,000 therms of gas for delivery in March next year at 25p per therm Each day we can look at the average traded price for that month, and mark the value of the 10,000 therms to that price After two days we note that March is trading at 27p a therm, so we mark the physical value to the market price of 27p, and subtract the price we will pay, 25p. The unrealized P&L is therefore £200 ((27p - 25p) * 10,000). Each day we will need to repeat this calculation until the delivery is complete | ||
Realization | ||
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The p&l of trades (and cash flows) is described as:
Detail Most trades involve delivery at some point in the future Because the value of the commodity to be delivered is not known before the delivery, the value needs to be estimated or calculated from market data. For forwards and futures and other linear trade types the value may be estimated by a simple mark to market calculation For options and other non-linear trades the value may be calculated using the Black 76 method (derived from the earlier Black-Scholes method) We say the trade's value (its p&l) is unrealized because it is not yet known for certain, and is therefore a cause of market risk Once delivery has taken place, we know (or don't care about) the delivered value, the value of he trade is known and no longer varies. In effect the p&l is locked in, there is no more market risk associated with this trade and the p&l is said to be realized The p&l of a trade (or cash flow) moves from unrealized to realized when one or more of the following conditions has been met
Realization is the set of business rules that defines when p&l moves from unrealized to realized based on:
Realization is subjective: different organizations may have different business rules to determine realization | ||