Description:-
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 the 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.
What is CPI?
A Consumer Price Index (CPI) is a measure of the average price of consumer goods and services purchased by households. It is a price index determined by measuring the price of a standard group of goods meant to represent the typical market basket of a typical urban consumer.
CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. This is because steep rises in CPI during a short period of time typically denote periods of inflation and steep drops in CPI during a short period of time usually mark periods of deflation.
Why are they traded?
To transfer inflation risk from one counterparty to another.
Life cycle events: –
Return on CPI index and Libor.
OTCWIRE 