Inflation Swap

AAA

DEFINITION of 'Inflation Swap'

A derivative used to transfer inflation risk from one party to another through an exchange of cash flows. In an inflation swap, one party pays a fixed rate on a notional principal amount, while the other party pays a floating rate linked to an inflation index, such as the Consumer Price Index (CPI). The party paying the floating rate pays the inflation adjusted rate multiplied by he notional principal amount. For example, one party may pay a fixed rate of 3% on a two year inflation swap, and in return receive the actual inflation.

INVESTOPEDIA EXPLAINS 'Inflation Swap'

Investors use inflation swaps to hedge inflation risk. A more complicated example of an inflation swap would be an investor purchasing commercial paper. At the same time, the investor enters into an inflation swap contract, in which he receives a fixed rate and pays a floating rate linked to inflation. By entering into an inflation swap, the investor effectively turns the inflation component of the commercial paper from floating to fixed. The commercial paper gives the investor real LIBOR plus credit spread plus a floating inflation rate, which the investor exchanges for a fixed rate with a counterparty.

RELATED TERMS
  1. LIBOR

    LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate ...
  2. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket ...
  3. Notional Principal Amount

    In an interest rate swap, the predetermined dollar amounts on ...
  4. Floating Interest Rate

    An interest rate that is allowed to move up and down with the ...
  5. Fixed Interest Rate

    An interest rate on a liability, such as a loan or mortgage, ...
  6. Swap

    Traditionally, the exchange of one security for another to change ...
RELATED FAQS
  1. What risks should I consider taking a short put position?

    The risks to consider before taking a short put position are the odds of sustained weakness in the asset price and a spike ... Read Full Answer >>
  2. What happens if a software glitch fails to execute the strike price I set?

    If you've ever suffered the frustrating experience of having an order not filled or had a strike price fail to execute because ... Read Full Answer >>
  3. In what market situations might a short put be a profitable trade?

    Short puts would be a profitable trade in low-volatility bull markets or range-bound markets. Selling puts is a strategy ... Read Full Answer >>
  4. What is the relationship between implied volatility and the volatility skew?

    The volatility skew refers to the shape of implied volatilities for options graphed across the range of strike prices for ... Read Full Answer >>
  5. How is a short call used in a collar option strategy?

    An investor uses a short call sold above the current market price to collect a premium in a collar option strategy. The core ... Read Full Answer >>
  6. Why should investors consider the fully diluted share amount?

    Investors should consider a company's fully diluted share amount before purchasing the company's stock, because it could ... Read Full Answer >>
Related Articles
  1. Options & Futures

    An Introduction To Structured Products

    Learn a simple way to bring the benefits of derivatives into your portfolio.
  2. Investing Basics

    The Barnyard Basics Of Derivatives

    This tale of a fictional chicken farm is a great way to learn how derivatives work in the market.
  3. Options & Futures

    Are Derivatives Safe For Retail Investors?

    These vehicles have gotten a bad rap in the press. Find out whether they deserve it.
  4. Options & Futures

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  5. Bonds & Fixed Income

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  6. Investing Basics

    What is a Greenshoe Option?

    A greenshoe option is a provision in an underwriting agreement that allows the underwriter to buy up to 15% of the shares in an IPO at the offer price.
  7. Investing Basics

    What Does a Clearing House Do?

    A clearing house is a third-party agency or separate entity that acts as a go-between for buyers and sellers in financial markets.
  8. Options & Futures

    How The New NYSE Binary Options Work

    The New York Stock Exchange has launched its own version of binary options called Binary Return Derivatives Options or ByRDs.
  9. Mutual Funds & ETFs

    4 Ways You Can Invest In Gold Without Holding It

    Owning gold can be a store of value and a hedge against unexpected inflation. Holding physical gold, however, can be cumbersome and costly. Fortunately, there are several ways to own gold without ...
  10. Active Trading Fundamentals

    How To Short Amazon Stock

    With the stock reaching all-time highs and the company gambling on several new business lines, many investors may feel it's a good time to short sell Amazon.

You May Also Like

Hot Definitions
  1. Social Security

    A United States federal program of social insurance and benefits developed in 1935. The Social Security program's benefits ...
  2. American Dream

    The belief that anyone, regardless of where they were born or what class they were born into, can attain their own version ...
  3. Multicurrency Note Facility

    A credit facility that finances short- to medium-term Euro notes. Multicurrency note facilities are denominated in many currencies. ...
  4. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
  5. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  6. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!