Inflation Swap

An inflation swap is a derivative with a fixed expiry used by investors to hedge against inflation. One side of the swap is a zero-coupon fixed leg; the other leg is also zero coupon and cash flow is defined as the inflation index level at maturity divided by the inflation index level at inception minus 1. One counterparty will pay fixed and receive inflation; the other will pay inflation and receive fixed. Typically, the zero coupon fixed rate will be calculated such that the swap has zero value at inception. Cash flows are exchanged at expiry. If the inflation rate falls below the fixed rate, the counterparty receiving inflation will lose money and pay a netted amount to the counterparty paying inflation.