Chapter 12Hedging Inflation Risk

This chapter covers the main issues affecting inflation risk hedging. Inflation-linked ­contracts are an integral part of the day-to-day business of many industries. For ­example, inflation may have a significant impact on the profitability and competitive ­position of highway ­companies. Inflation-linked instruments make it possible to manage inflation risk.

Before I address the accounting effects of inflation hedging decisions, I provide a basic understanding of the inflation markets.

12.1 INFLATION MARKETS – MAIN PARTICIPANTS AND INDICES

This section introduces the reader to the inflation markets by presenting an overview of the market's main participants and indices.

12.1.1 Inflation Market Participants

Inflation markets attract a diverse group of participants. In general, these participants can be categorised as inflation payers or receivers (see Figure 12.1).

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Figure 12.1 Inflation market – main participants.

Inflation Payers

Inflation payers are typically entities with direct or indirect inflation-linked revenues. ­Inflation is paid predominantly for the purpose of creating financial expenses that match these ­revenues. Inflation payers include the following:

  • Sovereigns. Theoretically, paying inflation can smooth the cash flows of governments as a substantial proportion of governments' incomes are at least partially inflation-linked. ...

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