A CPI-linked swap where counterparties exchange a floating nominal rate like LIBOR on an annual basis against an inflation-indexed bond with annual coupons and maturity payment adjusted to inflation rate. This swap allows parties to manage the risk of inflation being lower or higher than anticipated. A real rate swap is similar to an interest rate swap, except that it uses real rates (interest rates that are net of inflation), rather than nominal interest rates. As such, it provides a much better hedge for future real assets and real liabilities. For example, a pension fund can invest in a portfolio of fixed-rate bonds and exchange the fixed cash flows for cash flows that match the timing and inflation characteristics of its pension outgoings.
October 31, 2023