What are Inflation Derivatives?
Inflation derivatives or inflation-indexed derivatives are a subclass of derivatives which is used by investors to hedge the risk of increasing inflation. Many investors prefer them over inflation-indexed bonds (e.g.: Treasury Inflation Protected Securities TIPS and UK Inflation Linked Gilts), as they offer more flexibility and as they don’t require large amount of capital investments.
There are many products available under the category of inflation derivatives. They include inflation swaps, more specifically zero-coupon inflation swaps, options on inflation, and asset swaps. In swaps, one party pays at a fixed rate and the counter party pays at a rate based on the inflation rate of that period. This can be on a monthly or tri-monthly basis or on a year-on-year (YOY) basis.
For example take an inflation swap between A and B for a value of $10,000 for a year, where A – the inflation seller - agrees to receive a fixed/floating rate of payment from the counter party and B – the inflation buyer – agrees to receive an unknown payment, which will correspond inflation. If the fixed rate of payment is 6% and inflation is 7.1% for that year, then A receives a payment of $600 and B receives a payment of $710. In most cases Consumer Price Index or CPI is taken as the measure of calculating inflation.
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There are many products available under the category of inflation derivatives. They include inflation swaps, more specifically zero-coupon inflation swaps, options on inflation, and asset swaps. In swaps, one party pays at a fixed rate and the counter party pays at a rate based on the inflation rate of that period. This can be on a monthly or tri-monthly basis or on a year-on-year (YOY) basis.
For example take an inflation swap between A and B for a value of $10,000 for a year, where A – the inflation seller - agrees to receive a fixed/floating rate of payment from the counter party and B – the inflation buyer – agrees to receive an unknown payment, which will correspond inflation. If the fixed rate of payment is 6% and inflation is 7.1% for that year, then A receives a payment of $600 and B receives a payment of $710. In most cases Consumer Price Index or CPI is taken as the measure of calculating inflation.
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Online Futures Trading, Online Forex Trading
Worldwide Brokerage Service, Day Trading Brokerage
posted by NobleTrading at
8:22 AM
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