DEFINITION of 'Inflation Derivatives'
A subclass of derivative that is used by individuals to mitigate the effects of potentially large levels of inflation. The most common type of inflation derivatives are swaps, in which a counterparty's cash flows are linked to a price index and the other counterparty is linked to a conventional fixed or floating cash flow.
BREAKING DOWN 'Inflation Derivatives'
Many investors prefer inflation protection from derivatives because unlike inflation-indexed bonds, a significant amount of capital isn't required and it's more flexible. Inflation derivatives require the buyer to provide a small premium to the swap provider.
In most cases the Consumer Price Index (CPI) is used measure the differences in annual inflation.