Zero coupon inflation swap rate

Consumer Price Index swaps market was dominated by zero-coupon inflation swaps, similar to the major European inflation swaps markets.

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  • Zero Coupon Inflation Swap Definition | Finance Dictionary | MBA;

In a zero-coupon swap, the flows are very simple. One party pays a fixed rate on a given notional amount, compounded annually and paid in a single payment at the maturity of the swap. So, for example, in a USD10 million five-year zero-coupon swap the fixed payer might pay 2. The fixed-rate payer wins if compounded inflation is above 2. This fixed rate is the rate quoted in the market, so the market for five-year zero-coupon swaps might be 2. One party in this trade buys the asset from the counterparty--in this case, the asset is a particular TIPS bond--and pays all flows of the bond to the counterparty while receiving floating LIBOR minus a fixed spread, quarterly, for the life of the bond.

Note that the flows of the bond in the case of TIPS include the inflation uplift at the maturity of the bond. In the U.

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The asset swap is meant to simulate a buy-and-hold-and-finance strategy, and what is quoted in the market is the funding leg. This means that, over time, the receiver of TIPS flows--the seller of the asset swap in market parlance--almost always develops credit exposure to the payer of TIPS flows. While many counterparties in today's market enjoy full collateralization, some do not and this may have implications for pricing. But, as with conventional Treasury asset swaps, the predominant determinant of asset swap levels is the cost of funding the physical TIPS position. When the U.

Derivative Strategies - Zero Coupon Swaps Pricing (ZCSP)

CPI swaps market started in , asset swaps were not on the interbank menu. The structure was very popular with hedge funds, however.

  • Zero Coupon Inflation Swap?
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As a result, in asset swaps began to trade in the interbank market off the back of those hedge fund flows. The advantages of the zero-coupon inflation swap structure are its simplicity, the elemental nature of the bet on inflation, and its usefulness for curve construction.

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  • Zero-Coupon Inflation-Indexed Swap.
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The disadvantages lie in the execution of the instrument. Since many market participants care more about the basis between the swap flows and the TIPS breakeven inflation rate, a buyer of zero-coupon swaps often needs to execute a hedge in TIPS breakeven inflation and this limits the size of trade that can be done. The second disadvantage of zero-coupon swaps is tied to seasonality. While a spot zero-coupon swap has scant exposure to the seasonal pattern of inflation since it is quoted in round numbers of years, a seasoned zero-coupon swap will have some exposure to seasonal patterns except for the one day out of the year when it happens to have a whole number of years remaining to maturity.

While this can be a problem for clients who want to unwind an existing trade, the market is becoming more efficient at pricing for seasonality and the re-launch of CPI futures in early should lessen this disadvantage. The advantages of the TIPS asset swap structure are its familiarity and its stability, although as noted previously that familiarity is somewhat illusory since the underlying asset is dissimilar in some ways to Treasuries.

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TIPS asset-swaps can be more liquid, at least in principle, since the nature of the trade is that the asset is exchanged for the asset's flows. But there are some big problems with the asset swap structure, too.

Zero-Coupon Inflation-Indexed Swap - Wikipedia

While unwinding an asset swap can be easier than unwinding a zero-coupon trade since the structure is quoted in the market, this is not the same as saying that seasonality is not a problem with the asset swap structure. Quite the contrary: except for one day out of the year, an asset swap has seasonality issues as well.

The apparent stasis of asset swap spreads reflects market participants' belief that the TIPS market fully accounts for known seasonal biases. Even if this were the case, however, a major impediment to the market-standard aspirations of asset-swap devotees is that creating a swap curve--the sort that can be used to price other derivatives or new issues of inflation-linked bonds--from asset swaps forces one to back out seasonality that may or may not be accounted for in the bonds themselves.

Zero Coupon Inflation Swap

Consider analogously the problems that would be encountered if one tried to create a LIBOR curve, given only the asset swap levels of all of the Treasury bonds extant. The idiosyncrasies of the bonds would make that task well-nigh impossible. Moreover, a TIPS asset swap trade is not precisely a bet on inflation.

The asset being exchanged is not based on inflation, but pays a real rate and its value fluctuates based on changes in real rates. The asset swap stripped of the hedge exchange involves a bet on real rates, with incidental bets on TIPS bond idiosyncrasies and the level of general collateral - LIBOR spreads.

Since this swap probably would be executed as a spread in the LIBOR market, the trader would then have two swaps and an offsetting breakeven inflation position: long Treasuries, short TIPS against the swap position paying fixed and receiving TIPS flows. If you are new to GlobalCapital or you already subscribe to some of our channels you can still easily extend your access. Take a trial to the entire site or subscribe online to see all our capital markets news, opinion and data sets.

What will you receive? You are receiving: CPI appreciation x Notional. You said "you have" the swap, so I assume you are the fixed rate payer. Sign up to join this community. The best answers are voted up and rise to the top. Home Questions Tags Users Unanswered. Asked 4 years, 2 months ago.

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Active 4 years, 2 months ago. Viewed times. Guenther Guenther 8 2 2 bronze badges. Helin Helin 8, 1 1 gold badge 16 16 silver badges 35 35 bronze badges. Specifically for inflation swaps, there are a lot of really good sell-side research papers. What are you paying? You are paying the zero coupon rate. Sign up or log in Sign up using Google. Sign up using Facebook.