What are inflationary derivatives?

Inflation derivatives are a type of insurance used to protect against inflation on investment value. The most common type of inflation derivative is called credit swap. This is when one side exchanges cash flow flows with another party. The seller's flow flow is connected to the inflation index and when the inflation index increases, the buyer receives a return. This return compensates for the loss of value from other investments.

In order to actually understand inflation derivatives and how to help investors manage the risk, it is important to understand what inflation is, or more importantly, how it affects the value of currency and investment assets. Inflation is an increase in the price of goods and services over time. Most countries strive for a degree of inflation between 2 and 3 percent. It is normally measured annually. As prices rise, the currency value decreases. As a result, consumers must pay the same amount for an aperter amount of goods or services.

There are three main types of inflation: deflation, hyperinflation and stagflation. Deflation is the oppositeinflation. Hyperinflation is the exponential growth of inflation over time. Stagflation is a combination of high unemployment, economic recession and inflation. The most serious problems occur when inflation is unexpected and markets react with uncertainty about the future direction of the economy.

One way to fight inflation is through marginal contracts. Unfortunately, wage contracts can only help ensure the effects of inflation on the consumer's bank account. Inflation derivatives are used to manage and reduce risk within the investment portfolio.

Inflation derivatives began in the UK in the early 90s. Since then, the market with different types of inflation derivatives has grown across countries and industries. The consumer price index (CPI) is the most commonly used inflation measure. Other types of international inflation indices are French CPI, euro area, USA CPI and UKPI.

InvestThe steers prefer to purchase insurance against inflation through derivatives because they require capital less in advance than traditional inflation indexed bonds. Investors in inflation derivatives must pay the seller a small premium for coverage. The transaction is like paying for car insurance, with the exception of inflation of protected bonds, it requires a complete initial investment value. In most cases it is at least $ 1,000 in the US (USD). Inflation derivatives are also less liquid than indexed bonds, which is generally less risky.