Inflation protection

Sodium azide is used to inflate protective air bags in automobiles. What mass of solid sodium azide is needed to provide 100 L of N2 at 1.5 atm and 20°C ... 

Where are the new opportunities to improve portfolio performance by creatively expanding the investable asset domain There are several assets that are now increasingly accepted and utilized in portfolios. The most important are hedge funds, private equity, and venture capital. Other new assets have shown the ability to improve portfolio performance but for various reasons have not yet made the leap to widespread recognition. These include inflation-protected securities and insurance-linked products. 

Treasury inflation-protected securities (TIPs) are one of the most innovative financial products to appear in recent years. They pay a real coupon, plus the return on the Consumer Price Index (CPI). Thus, they automatically protect investors 100% against rising inflation, a property no other security possesses. Further, in a rising inflation environment, returns on TIPs are negatively correlated with those of bonds and other assets whose prices tend to decline when inflation rises. 

Lamm, R. M. (1998a), Asset Allocation Implications of Inflation-Protection Securities Adding Real Class to Portfolios, Journal of Portfolio Management, Vol. 24, No. 4, pp. 93-100. 

Lamm, R. M. (1998b), Inflation-Protected and Insurance Linked Securities, Treasurer, February, pp. 16-19. 

Assessments, energy, 1578-1579 Asset classes, 758-761 currencies, 761 enhanced index products, 761 hedge funds, 759, 760 insurance-linked products, 761 private equity and ventme capital, 759-761 Treasury inflation-protected securities (TIPs), 761... 

Index-linked or inflatiOTi-indexed bonds present additional issues in their analysis, due to the nature of their cash flows. Measuring the retimi on index-linked bonds is less straightforward than with conventional bonds, and in certain cases there are peculiar market structures that must be taken into accotmt as well. For example, in the United States market for index-linked treasuries (known as TIPS from Treasury Inflation-Indexed Securities) there is no significant lag between the inflation link and the cash flow payment date. In the United Kingdom, there is an 8-month lag between the inflation adjustment of the cash flow and the cash flow payment date itself, while in New Zealand there is a 3-month lag. The existence of a lag means that inflation protection is not available in the lag period, and that the return in this period is exposed to inflation risk it also must be taken into account when analysing the bond. 

As described above, inflation-linked bonds allow to save investors from changes in the general level of prices. However, the indexation is not perfect creating a lag between the index prices and the adjustment to the bond cash flows. According to Deacon and Derry (2004) at the end of a bond s life there is no inflation protection, matched with an equal period before the issue in which the inflation compensation is paid. Figure 6.11 shows an example of indexation lag according to Deacon and Derry (2004). 

Jarrow, R., Yildirim, Y., 2003. Pricing treasury inflation protected securities and related derivates using an HIM model. 1. Financ. Quant. Anal. 38 (2), 337-358. 

Needless to say, we do not live in a two-asset world, and this complicates matters further. An investor might place a high inflation risk premium on an index-linked bond when only nominal alternatives are available, but the value attributed to the risk premium will also be influenced at least a little by the availability of competing assets offering some degree of inflation protection—the more classic inflation hedges such as real estate and land. 

Investors tend to prefer their domestic habitat. When they have domestic liabilities, their first choice will probably be domestic assets. This is all the more likely in index-linked markets, where the inflation protection offered by an Australian linker is likely to be far more valuable to... 

The Eurozone IL swap market started trading in May 2001, months before the Tresor issued the first Eurozone IL bond, the OATei 2012. The introduction and hedging of retail inflation protected equity products (e.g., those issued by the Italian Post Office and others) helped to kick off activity in the interbank Eurozone IL swap market, which has seen a steadily increasing uptrend in volumes traded per month. As of May 2003, pension related IL swaps and swaps from corporate payers are still a rarity, however some infrastructure driven hedging is taking place. 

Duration increases as coupon and yield decrease. The lower the coupon, the greater the relative weight of the cash flows received on the maturity date, and this causes duration to rise. T ong the non—plain vanilla types of bonds are some whose coupon rate varies according to an index, usually the consumer price index. Index-linked bonds generally have much lower coupons than vanilla bonds with similar maturities. This is true because they are inflation-protected, causing the real yield required to be lower than the nominal yield, but their durations tend to be higher. 

Jarrow, R., and Y. Yildirim. 2003. Pricing Treasury Inflation Protected Securities and Derivatives using an HJM Model. Journal of Financial and Quantitative Analysis 38, June. 

Treasury Inflation-Protected Security (TIPS) A security that is identical to a Treasury bond except that principal and coupon payments are adjusted to eliminate the effects of inflation. 

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