Zero Coupon Inflation Swap

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Definition of 'Zero Coupon Inflation Swap'

A zero-coupon inflation swap (ZCI swap) is a financial derivative contract in which two parties agree to exchange a series of inflation-indexed payments for a series of fixed payments. The payments are made at regular intervals, typically quarterly or semi-annually. The notional amount of the swap is the principal amount that is exchanged at the start of the contract.

The party that agrees to pay the fixed payments is called the fixed payer. The party that agrees to pay the inflation-indexed payments is called the inflation receiver. The inflation-indexed payments are based on a specified inflation index, such as the Consumer Price Index (CPI).

The value of the ZCI swap at any given time is equal to the present value of the future inflation-indexed payments, discounted at the fixed rate. The fixed rate is the rate that makes the present value of the fixed payments equal to the present value of the inflation-indexed payments.

ZCI swaps are used by investors to hedge against inflation risk. For example, an investor who is concerned about the potential for future inflation may enter into a ZCI swap to lock in a fixed rate of return.

ZCI swaps can also be used for speculation. For example, an investor who believes that inflation will be higher than expected may enter into a ZCI swap to receive the inflation-indexed payments.

ZCI swaps are typically traded over-the-counter (OTC). The terms of the contract are negotiated between the two parties, and there is no central exchange where ZCI swaps are traded.

ZCI swaps are a complex financial instrument and should only be used by investors who understand the risks involved.

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