What is an inflationary exchange?

Inflation swap is a financial product that converts the risk of inflation between the parties. These swaps are part of the wider class of inflation derivative products that include any product that is based on the inflation rate. Inflation swap is a linear inflation derivative, which means that regardless of the level of inflation, the change in inflation corresponds to a specific change in the value of the swap. Investors use these products to buy and sell inflation risk to speculate or protect themselves from changes in inflation levels. Some entities write inflation swaps to finance other investments that have similar risks with them. Investors are afraid of increased inflation as they decrease to actual yields. For example, if an investor buys a bond, he expects to obtain the nominal value of the bond when he matures. For example, if they pay $ 900 for a $ 900 (USD) bond in one year and has a nominal value of $ 1,000, it expects to be 11 % of return. However, if inflation is 2 percent, the nominal value of the bond is only1 000/1.02 = 980.39 $ in terms of dollars from the previous year, so its real return is only about 9 percent.

The investor could create a maximum inflation rate by participating in the exchange of inflation. He agreed to pay a fixed rate for a certain amount, and in exchange another party would pay him the rate of inflation on the same principal. The inflation rate, which determines what is paid in these swaps, is generally based on the consumer price index or on CPI, which monitors the change in the price of the basket over time. As the payment of inflation is determined, it depends on the type of inflation.

Many inflation swaps are zero coupons, which means that the amounts of money are only exchanged at the end of the Life exchange. It is a commonly two -year or five -year swap and the inflation rate is cumulative all the time. Some swaps have coupons, which means that parties exchange payments at the end of the specified periods that can be every month or up to a year. The payment of the inflation rate is determined according to the annual or year -on -year inflation rate.

Investors could choose to buy inflation swaps if they are afraid of increased inflation and want to lock a specific rate. They then face the risk of reducing inflation, which worsens them. Institutions such as governments that have products whose costs depend on inflation writes inflation swaps. They know that swap return will be proportional to project costs, so they can finance projects using a swap revenue.