Managing Inflation Risk

Linkers, Derivatives Applications and Portfolio Strategies

Agenda Program
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Prague, NH Hotel Prague
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Inflation and Its Financial and Economic Implications
Measuring Inflation and Inflation Risk
Inflation-Linked Bonds and Notes
Inflation-Linked Swaps, Caps, Floors and Swaptions
Hedging Inflation Risk
Managing Inflation Risk in an ALM Context
Constructing Optimal Inflation-Protected Portfolios
The purpose of this seminar is to give you a good understanding of tools and techniques for managing inflation risk.

We start with an overall introduction to the inflation concept and a good discussion of its financial and economic implications: Erosion of purchasing power, money illusion, wealth redistribution and potential misallocation of resources. We also explain how inflation is sought controlled through fiscal and monetary policy.

We then explain how inflation and inflation risk is measured and how widely used inflation indexes such as CPI, CPI-U, HICP, DP Deflator etc. are calculated and how they should be interpreted. We also explain how inflation risk is measured on a "stand-alone" basis and in the ALM context of DB pension funds and insurance companies.

The central part of the seminar will be focused on inflation linked products and their applications. We start with a thorough introduction to inflation-linked bonds ("linkers"). We describe their basic mechanics and we give detailed examples of linkers that are traded and used in practice. These include US TIPS, French OATIs, UK Index-Linked Bonds etc. We give examples of the nominal and real cash flows of these bonds and we explain and demonstrate how real yield and real interest rate sensitivities are calculated. We also give examples of investment and trading strategies with inflation-linked bonds.

Further, we give an overview and explain the mechanics and applications of inflation-linked derivatives such as inflation futures, inflation swaps and inflation caps, floors and options. We also give examples of their applications in risk management.

Finally, we explain and demonstrate how inflation risk can be managed in an ALM context using linkers, inflation derivatives and real assets. We explain how real liabilities can be formally matched with bonds and synthetics and we show how instruments can be blended with the goal of constructing real risk-return optimized portfolios under inflation constraints.

Program of the seminar: Managing Inflation Risk

The seminar timetable follows Central European Time (CET).

09.00 - 09.15 Welcome and Introduction

09.15 - 12.00 Inflation and Its Financial and Economic Implications

  • Inflation and how it Can Effect the Real Value of Assets and Liabilities
  • Inflation and Deflation in a Historical Perspective
  • Key Drivers of Inflation
  • Monetary Policy, Fiscal Policy and Inflation

Measuring Inflation and Inflation Risk

  • Problems in Measuring Inflation
    • Which “basket” to use?
    • Changes in product quality over time
  • Widely Used Inflation Indexes
    • CPI, CPI-U, CPI-W, PPI, and PCE
    • Eurozone HICP
    • “Core” vs. “Headline” CPI
  • The GDP Deflator as Broad Measure of Inflation
  • More Specialized Indexes
    • Employment Cost Index
    • International Price Program (IPP)
  • Measuring Inflation Risk
    • Measuring inflation risk in an ALM context (pension funds etc.)
    • Estimating inflation premia
    • Forward inflation vs. break-even inflation
    • Stochastic models of inflation
  • Practical Examples and Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Inflation-Linked Bonds and Notes

  • Inflation-Linked Bonds - Mechanics and Concepts
  • Arguments for Issuing Inflation-Linked Bonds
  • Arguments for Investing in Inflation-Linked Bonds
  • Overview of Most Important Cash Flow Structures
    • Capital Indexed Bond (CIB)
    • Interest Indexed Bond (IIB)
    • Current Pay Bond (CPB)
    • Indexed Annuity Bond
    • Indexed Zero Coupon Bond
  • Yield Calculations, Break-even Inflation and Sensitivity Analysis
  • Major International Indexed Bond Markets
    • US TIPS
    • UK inflation-linked gilts
    • French OATis
  • Inflation-Linked Bond Trading and Investing Strategies
  • Case Studies and Small Exercise

09.00 - 09.15 Recap

09.15 - 12.00 Inflation-Linked Derivatives

  • Overview of Participants and Instruments in the Global Inflation Market
  • Inflation Swaps
    • Market conventions
    • Zero-coupon inflation swaps
    • Revenue inflation swaps
  • Inflation Options
    • Inflation caps and floors
    • TIPS options
    • Inflation swaptions
  • Inflation futures
  • Pricing and Valuation of Inflation-Linked Derivatives
    • Decomposing break-even inflation
    • Valuing inflation swaps
    • Valuing inflation options
  • Inflation Derivatives Applications
    • Managing inflation risk in an ALM context
    • Constructing inflation linked structured products
    • Index linked guaranteed performance notes
    • Inflation volatility considerations
    • Examples of hybrid products with embedded inflation options
    • Practical trading applications
    • Post-crisis approaches to trading inflation derivatives
  • Case studies and small exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Portfolio Strategies for Mitigating Inflation Risk

  • Use of Asset Classes Partly Correlated to Inflation
    • Floating rate securities
    • Equities
    • Commodities
    • Real estate
    • Gold and other precious metals
  • Sourcing of Inflation Sensitivity
    • E.g. investing in infrastructure projects
  • Formal Inflation Matching
    • Inflation-linked bonds and synthetics (e.g. swaps)
    • Swaps wrapped in pooled funds
  • Portfolio Optimisation Under Inflation Constraints
    • Use of a stochastic model to provide long term optimisation
    • Constructing optimal portfolios incorporating inflation swaps
    • Case Study and Small Exercise

Evaluation and Termination of the Seminar

Training catalogue in PDF
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