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When too much money is chasing too few goods- Inflation happens.

The relative value of any two products /services changes with time. For example, we
can’t base inflation on the price increase of one product. We take a sample, or basket of
different goods and services to establish the level of inflation. In Singapore, the CPI is
based on the average prices of more than 5,000 brands and varieties of goods.

Price indices are defined with respect to different baskets and calculated by various
national agencies.
The Statistics Office of different countries publish the index for their countries.

In India, Inflation is calculated on the basis of the Wholesale Price Index. In most other
countries, it is calculated using the Consumer Price Index. Which is a better indicator?

WPI- if we want to know how inflation affects the whole economy

CPI- if we are looking at common man.

Inflation-linked bonds: Provide protection against inflation. The principal amount of the
bond increases with inflation, thus the interest rate is applied to the increased amount.
This causes the interest payment overtime. At maturity, the principal is repaid at the
inflated amount. Thereby the investor is protected from unexpected changes in CPI.

The first known inflation-indexed bond was issued by the Massachusetts Bay Company
in 1780. The British government began issuing inflation-linked Gilts in 1981.

Most common inflation-linked bonds are:

:The British Inflation-linked Gilt(ILG)

US Treasury “Inflation-protected Security” (IPS)

Canadian Real Return Bond(RRB)

HSBC Emerging Markets Inflation-Linked Bond

What sets inflation-linked bonds apart from traditional bonds is that both the initial
principal amount and the coupon payments are indexed to the inflation rate. Inflation –
linked bonds are suitable for those who are keen to preserve their purchasing power
regardless of the future inflation rate. As we are aware, inflation can erode savings over
time if nothing is done.'
So even if the inflation rate decreases, it would have to go negative before investors see a
decline in the value of their investment. As such, inflation-linked bonds may
underperform traditional bonds in a low inflation environment.

Another disadvantage is that an inflation-linked bond fund which invests in emerging
markets may face the risk of volatility in emerging market currencies. If the fund is
hedged, there is a cost to it, which reduces the return to the fund.

In 1996, the United States issued its first Treasury Inflation Protected Securities, or Tips,
and since then, has been followed by France, Italy, Greece, Germany, Sweden and Japan.

The current size of the inflation-linked bond market is about US$1.5 trillion (S$2
trillion).

Inflation swap: the inflation market is still not completely unified as it is still

at the early development stage. Inflation swap can exist many in three

forms:

Zero coupon inflation swaps: consisting in a stream of exchange at

maturity between a fixed payment and the notional accreted over the

whole period at the inflation rate. At maturity, pays therefore

()() % 100 0 / − − CPI lag T CPI , versus a fixed payment of the form

() % 100 % 100 − + T

Infl , where the zero coupon swap rate Infl is such

that the swap has zero NPV.

Revenue inflation swap: this would be the equivalent of a swap as at

each period, there is an exchange of payment between inflation linkedcashflows, that
have accreted at the inflation rate:

()() % 100 0 / − − CPI lag T CPI , and a fixed payment accreting at the swap

rate () % 100 % 100 − + T
Infl . A revenue inflation swap is therefore

nothing more than a series of zero coupon inflation swap.

Year-On-Year inflation swap: at each period (every year), there is an

exchange of payment between an inflation linked payment but

accreting only for the last year () lag T CPI − / () % 100 1 − − − year lag T CPI

versus a fixed cashflow paying Infl .

Inflation swaps are very attractive to client as they are highly customisable:

ability to specify the appropriate inflation index, ability to match the risk profile

in term of the structure, and great accounting benefit as this can easily qualify

as an hedging trade. Zero coupon inflation swaps bear a substantial credit risk

exposure compared to revenue inflation and year on year inflation swaps as it

pays a single payment at maturity.

Inflation structured products: these are tailor-made products addressing

specific clients’ preoccupations. For instance, common structures are:

Standard vanilla like caps, floors and swaptions on inflation.

Event-trigger structures on inflation: like right to enter into an inflation

linked note depending on a third party asset like price of oil or a commodity index.
Useful for utility companies and cheaper than

standard structures.

Yield enhancement or financing cost reducing inflation structure: for

investors that issue an inflation-linked note, selling the option to enter into a payer
inflation swap can offer substantially lower financing cost
(on the liability side) or increase the yield (asset side) on the structure.

Useful for inflation-linked issuer or for inflation-linked investors.

Callable inflation structures: Callable inflation bonds offering to an

investor the right to call back the inflation-linked issue at a set of early

redemption dates to protect him against an inflation surge. As a matter,

this can just be seen as a Bermudan inflation swap.

Spread option on inflation paying the spread between two inflation

indexes, for instance Spanish inflation and harmonized European

inflation, with some capped and/or floor. Useful as a hedge against the

inflation rates differential between different countries. Other slight

variations of the inflation spread options are structures paying the

maximum of two inflation rates.

And many more exotics like quanto inflation structure, where the US

inflation is paid in Euro, Best-Of, Worst-Of and all the standards

correlation hybrids products structured on inflation and other assets,

like equity stock, foreign exchange, fixed income, commodity and credit

indexes, real capital guaranteed products, where the real notional is

protected.
In Year One, the bond fund's principal will be adjusted according to the inflation rate,
where a $100 principal will be adjusted to $103 and investors will receive 4 per cent of
the inflation-adjusted principal of $103, which works out to $4.12.

The Bureau of Labor Statistics releases the CPI around the middle of each month for the
previous month. The CPI measures a “basket” of goods and services and compares the prices
month to month.

This basket contains hundreds of different types of goods and services ranging from the
inexpensive to very expensive. They come from stores both large and small and from big and
small communities.

If inflation is high, Federel bank will raise the interest rate or lending rate in an effort to
prevent inflation getting out of hand.

When lending rate is high, means banks will charge high interest to businesses or individuals,
thereby discouraging the businesses to go for it thereby limiting the produce

For USA, Bureau of Labor Statistics publish CPI-U.
For France
RPI – Retail Price Index represents the total expenditure of a typical household
CPI – Consumer Price Index represents the same as above but excluding housing-related
expenses such as Mortgage Payments, Council Tax
CPI-U – This index is chosen to represent the expenditure of urban residents(87% of
population as of 2006