An inflation swap is an agreement between two counterparties to swap fixed rate payments on a

notional principal amount The notional amount (or notional principal amount or notional value) on a financial instrument is the nominal or face amount that is used to calculate payments made on that instrument. This amount generally does not change and is thus referred to a ...

for floating rate payments linked to an inflation index, such as the consumer price index.How Liquid Is the Inflation Swap Market?
Michael J. Fleming and John Sporn, 2013 An inflation swap is the linear form of an

inflation derivative In finance, inflation derivative (or inflation-indexed derivatives) refers to an over-the-counter and exchange-traded derivative that is used to transfer inflation risk from one counterparty to another. See Exotic derivatives. Derivative Typical ...

, and used to transfer

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...

risk from one counterparty to another.

Example

An investor takes out a 5 year loan that is repaid at LIBOR+1%. He considers this rate as the sum of real LIBOR plus a credit spread (1%) plus a floating inflation component. He would like to pay real LIBOR, the credit spread, and a fixed rate. So he enters into an inflation swap agreement where for the next 5 years he is paying a fixed rate on his loan's principal while receiving year-on-year inflation on the same amount.

References

Inflation Derivatives (finance) Swaps (finance) {{finance-stub

Example

See also

References