An inflation swap (a zero-coupon swap) in which a fixed amount is exchanged at a specified maturity for the limited-price indexation (LPI) return over the life of the swap. The LPI is a UK inflation index used to define typical payout structures of UK pension schemes. LPIs have annual returns that are equal to the corresponding annual UK inflation rates capped and floored at specific levels, for some strike levels. Historically the cap and floor were set at 5% and 0%, respectively [the swap is typically expressed as LPI (0, 3)], or more recently 3% and 1%, respectively [the swap is expressed as LPI (1,3)]. In the UK, many pension liabilities are inflation-linked but with a cap/ floor collar on year-on-year inflation growth. The pension scheme enters into a contract where, in exchange for an annual fixed sum, it receives collared inflation-linked payments.
This swap is also known as a limited-price index swap or simply as LPI swap.
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