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When I try to make a callout to SAP PI Endpoint- https 121.XX.XX.111:8082/XISOAPAdapter/MessageServlet......., below error is thrown.

Error: System.CalloutException: IO Exception: java.security.cert.CertificateException: No subject alternative names matching IP address 121.XX.XX.111 found.

I have generated Self-signed certificate in sfdc and imported in PI. Will Self-signed certificate work? Do I need CA-Signed Certificate?

Also, is there any restriction in salesforce that callout endpoint should not be server IP but server hostname?

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If you are doing one way SSL ,then you don't need a signed certificate from SFDC and instead you can use CA signed certificate directly on the PI end purchased from vendors Verisign,Thawte ,etc.

The other option is as you are doing but this needs to be publicly CA signed .This article should help you how to get your salesforce certificate CA signed.

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