An inflation derivative that pays out if inflation (as measured by percentage increase in the consumer price index, CPI) drops below a certain level (threshold) over a specified period of time. For example, a 3-year inflation floor with a strike price of 1% pays the buyer the rate of deflation (the decrease in inflation) on a notional amount during any of the next three years which prices fall on average. The inflation floor is, so to speak, a deflation cap.

However, since official publication of CPI figures is carried out at a date later than the end of the period in question, the payout would have to be delayed to that date. The effective payout, then, differs from the “nominal” payout, as set out in the below two equations:

let a, b denote the start and end of a floor’s life, L denote the notional amount, and K refer to the strike, then:

Nominal payout @ b = L x min [0, K- ((C_b / C_a) – 1)]

C_a and C_b : consumer price index readings at (a) and (b) respectively.

effective payout @ b = L x P_bd min [0, K- ((C_b / C_a) – 1)]

where:

d denotes the later date at which inflation figures are effectively released

P_bd denotes inflation adjustment within the period between the end of a floor’s life and the actual release of inflation data.

The inflation-indexed floor is also known as an inflation floor.