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Are your business, projects or assets to fluctuations in interest rates, exhange rates, commodity prices or inflation ?

ESTER's experts advise you on the most appropriate hedging strategies.

Why hedge inflation or raw material risk?


When companies or projects are exposed to inflation, either through costs (labour, salaries, construction costs, cost of raw materials, etc.) or through revenues (indexation of contracts for the sale of electricity, rents, etc.), hedging exposure to inflation can make it possible to secure the company's financial equilibrium and the investor's IRR.  

How are inflation or raw materials risk hedged?

It is essential to determine the hedging structure best suited to the company's objectives and constraints, as well as to the specifics of the underlying market.  

 

There are inflation swaps and commodity futures. However, be careful, these instruments are all indexed to a few main indices, which rarely correspond precisely to the company's exposure. It is therefore crucial, if the company is considering hedging its risk, that it has negotiated indexation on hedgeable indices, or on indices close to hedgeable indices, in its various contracts. 

What is an inflation swap?

The most classic inflation swap is a cash flow swap in which one party pays a coupon indexed to a fixed rate and the other party pays a coupon indexed to an annual or cumulative inflation rate.  

Commodity Futures Contract

The challenges of hedging inflation risk

Before we can conclude whether inflation hedging is appropriate or feasible, a number of questions need to be answered : 

  • Where do asset and liability exposures come from, what inflation indices are involved, how much compensation is there between cost and income inflation, and what is the net exposure? 

  • On which amounts does the indexation apply, and how variable are these amounts (on the revenue and cost sides)? 

  • Is it possible to hedge this net exposure using market instruments? 

 

Understanding and measuring exposure, defining the underlying indices and any offsetting effects between the different indexations is the prerequisite for any inflation hedge. This stage can lead to the search for a natural hedge, or the search for financial hedging instruments.

 

Our articles on hedging inflation risk
 
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