(Deutsche Bank) Inflation - Hedging It and Trading It PDF

Deutsche Bank
Corporate and Investment Bank
Inflation
Hedging it & Trading it
Deutsche Bank
Corporate & Investment Bank
Winning for our clients:

Inflation Derivatives House of the Year.
At Deutsche Bank, we are dedicated to setting the
stage so that our clients can perform at their best.
We appreciate winning awards that recognize the
quality of service that we deliver.
This advertisement has been approved and/or communicated by Deutsche Bank AG London. The services described in this advertisement are provided by Deutsche Bank AG or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation.
Deutsche Bank AG is authorised under German Banking Law (competent authority: BaFin Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conduct of UK business. Securities and investment banking activities in the United States
are performed by Deutsche Bank Securities Inc., member NYSE, FINRA and SIPC, and its broker-dealer affiliates. Lending and other commercial banking activities in the United States are performed by Deutsche Bank AG, and its banking affiliates. Copyright Deutsche Bank 2011.
Contents
Introduction
Why inflation, why now?
1.0 Deutsche Banks capabilities and credentials in this market

1.1 How Deutsche Banks inflation offering differs from
competitors
2.0 Market Overview the rise and rise of inflation volatility

2.1 Components of Inflation indices
3.0 Inflation Linked Bonds

3.1 Inflation Linked Bonds

3.2 Real Yield and Breakeven Inflation and Inflation Protection

3.3 Indexation and Breakeven Inflation

3.4 Risk Measures, EM Sovereign Linkers, Seasonality,
and US TIPS

3.5 UK Index Linked Gilts, EUR Sovereign Linkers, and other
Important Markets

3.6 ILB coupon frequency and settlement characteristics
4.0 Inflation Swaps

4.1 ILS Swaps and Markets

4.2 UK Swaps, Corporate Linkers, and US Swaps

4.3 ILS Indexation

4.4 ILS Pension Fund demand
6.0 Inflation Options

6.1 Inflation Options

6.2 Who are the major players in the options market?

6.3 Option Products

6.4 What are the trading opportunities?

6.5 Option Strategies

6.6 Creating Optimal Hedges
7.0 Deflation tail risk

7.1 Deflation Tail Risk: DB 5 Year Note
8.0 Case Study Zero-Coupon Option Trade
9.0 Further Reading

9.1 Inflation Hedging for Institutional Investors
10.0 Contacts

10.1 Deutsche Bank Global Inflation Team
5.0 Assessing Relative Value

5.1 Linker Asset Swaps and the Leverage Effect

5.2 5 sources of Asset Swap Difference

5.3 What is the Fair Price for Inflation Protection?

5.4 Fair Credit Spread of Inflation Linked Bonds

5.5 Hedge with Bonds or Swaps

5.6 Summary
InflationHedging it & Trading it
Deutsche Bank
Contents
Introduction
Why inflation, why now?
Inflation Derivatives
House of the Year
There has never been a better

time to talk about inflation
Deutsche Bank is very strongly

positioned to advise clients on
what to do
The Deutsche Bank inflation

team has developed this briefing
document to:
Inflation looks set to be volatile

for the next 5 to 10 years
Any client with a bond portfolio
is exposed to inflation risk
Clients with revenues or
liabilities indexed to inflation
are especially vulnerable.
We were recently voted the

Best Inflation Derivatives house
in the industry by Risk magazine
We have a large global inflation
derivatives trading and
structuring team
We have extensive experience
of helping clients find inflation
solutions
Set out the challenges

and opportunities faced by
clients
Explain the products and
strategies we have developed.
Deutsche Bank
The Deutsche Bank Global

Inflation team can help
Contents
Deutsche Banks credentials and

capabilities in the Inflation market
How Deutsche Banks inflation offerings differ from
competitors
Deutsche Bank
Contents
1.0
capabilities in the Inflation Market
Deutsche Banks credentials and capabilities

in the Inflation Market
We offer a full range of
inflation services
Our primary capabilities are
demonstrated by our leading position
in the league tables; weve also played
an important role in maintaining order
in the secondary markets, distributing
and recycling bonds and swaps across
the world. DB is the global leader in
inflation-linked bond syndication.
Issuing long dated inflation in large

sizes can be difficult to manage; debt
managers turn to the strongest banks
who have the best track record for
risk management and distribution
Deutsche Bank leads in this space
Lead syndication mandates awarded to market counterparties
*between September 2009 and February 2011

Source: Bloomberg, Deutsche Bank
Date
Deal
No.
Leads
DB
UBS
24 Sep 09
UKTI50
29 Sep 09
ACGBi25
21 Oct 09
BTPei41
27 Jan 10
UKTI40
21 Apr 10
BTPei21
11 May 10
UKRAIL47
26 May 10
UKTI50
27 Jul 10
UKTI40
14 Sep 10
ACGBi30
01 Feb 11
NZGBi25
Total number
Deutsche Bank
RBS
Barc
GS
JPM
Nomura
BNPP
SG
Calyon
MPS
1
1
HSBC
1
1
1
1
1
1
1
7
Contents
1.0
We are outperforming the competition

around the world
Deutsche Bank is:
No 1 in ICAP market share for EUR
Inflation/Asset Swaps (2009, 2010)
No 3 in ICAP market share for
UKRPI Inflation/Asset Swaps
(2009, 2010)
No 1 in BGC market share for all US
products (Inflation, Asset Swaps,
Options) 2010
Fig.1: Expand
Global Linker Syndications as Lead
Manager
Fig. 2: Expand
Total Syndication Size for Global
Linkers (mm)
Deutsche Bank
Competitors
Deutsche Bank
Competitors
Number of
Syndications

Deutsche Bank
Competitors
7,000 Total Syndication

Size
6,000
12,000
10,000
5,000
8,000
4,000
6,000
3,000
3
2
2,000
1,000
4,000
2,000
Deutsche Bank
ANZ
MPS
Calyon
SocGen
ML
BNPP
MS
RBC
Nomura
GS
JPMC
HSBC
RBS
0
Barc
ANZ
MPS
Calyon
SocGen
ML
BNPP
MS
RBC
Nomura
GS
JPMC
HSBC
RBS
Barc
DB
UBS
DB
UBS
Fig. 3: Expand
USD Inflation Market by Volume 2010
Contents
1.0
We are outperforming the competition

in the UK
Fig. 3: Expand
UK Linkers Total Syndication Size (mm)
Fig. 1: Expand
UK Linkers Syndications as Lead
Manager

Deutsche Bank
Competitors

Deutsche Bank
Competitors
3.5
3,000
2,500
2.5
2,000
1,500
1.5
1,000
500
0.5
0
0
DB
UBS
RBS
Barc
HSBC
GS
JPM
Nomura
DB
UBS
RBS
Barc
HSBC
GS
JPM
Nomura
Fig. 2: Expand
UK Linkers and Nominals Syndications
as Lead Manager
Fig. 4: Expand
UK Linkers and Nominals Syndications
as Lead Manager
Deutsche Bank
Competitors
Deutsche Bank
Competitors
3.5
4,000
3,500
3,000
2.5
2,500
2,000
1.5
1,500
1,000
0.5
500
0
0
DB
UBS
RBS
Barc
HSBC
GS
Deutsche Bank
JPM
Nomura
DB
UBS
RBS
Barc
HSBC
GS
JPM
Nomura
Contents
1.1
How Deutsche Banks inflation offering differs

from competitors
Integrated trading, structuring
and research
Unlike some of our competitors,
Deutsche Banks inflation trading,
structuring and research professionals
work closely together, combining
strategic and technical expertise
with the macro-economic insights so
important to this offering.
Bloomberg
Forecasts, inflation linked bonds,
inflation swaps and inflation linked
options. US options will be added
soon (figure 1)
The market is pricing much more
upside risk than downside risk
contrary to what we see in other
markets
Fig. 1: Expand
Our inflation page on Bloomberg DBII
Fig. 2: Expand
Inflation on Trade Finder new
improvements coming soon
Trade Finder
Currently being upgraded, it will soon
include additional functionality: e.g.
forward matrices five year forward
on Eurozone or five year to 25 year
forward. In Frankfurt and Mumbai,
real live zero coupon lives and forward
matrices and cross market indicators
will soon be added (figure 2)
Deutsche Bank
Contents
Market Overview
Components of Inflation indices
Deutsche Bank
Contents
2.0
Market Overview the rise and rise of
market volatility
The rise and rise of inflation

All G7 nations issue inflation-linked
bonds
Markets
US TIPS the US Sovereign linker
market is the largest globally with a
total market value of over USD700bn
but less liquid than EUR
UK IL Gilts first issuance 1981; total
market value exceeds GBP270bn
EUR sovereign linkers - expanding
rapidly; total market value exceeding
EUR320bn as of now; France, Italy,
Germany & Greece issue ILBs. Italian,
German and Greek ILBs are linked
to euro area inflation; France issues
bonds linked to EUR inflation and
bonds linked to FRF inflation
Deutsche Bank
Industrial country sovereign linker

markets Other important markets
include Australia, Canada and Sweden.
AUD: govt suspended issuance in
2003, started again in 2009. Sweden:
linkers account for almost 30% of total
govt bond market, higher share than in
any other industrial market
EM sovereign linker markets - most
LatAm inflation markets have long
histories; Brazil is the largest market,
suppression of investment restrictions
in 2006 spurred international demand.
Chile, Colombia & Uruguay also issue
ILB. Israel is big (USD27bn market
value). More recently: South Africa,
Poland, Turkey (2007) and South Korea
(2007)
Fig. 1: Expand
A Fast Growing Asset Class
Source: Deutsche Bank

US
UK
JPY
FRF
CAD
1,600
ITL
DEM
Gr
SEK
AUD
total outstanding, $ bn
1,400
1,200
1,000
800
600
400
200
0
97
98
99
00
01
02
03
04
05
06
07
08
09
10
Contents
2.1
Market Overview the rise and rise of
market volatility
Components of Inflation Indices

Fig. 1: Expand
Weights in the US CPI
Fig. 2: Expand
Weights in the UK RPI
1,600
1,400
15
1,200
Food and beverages

Housing
Apparel
Transportation
Medical Care
Recreation
Education and
Communication
Other
1,000
800
600
17
42
400
1,400
Food and catering

Alcohol and tobacco
Housing and
household expenditure
Personal expenditure
Travel and leisure
165
1,200
257
1,000
88
800
82
600
400
408
200
200
1,600
0
97
98
99
00
01
Fig. 3: Expand
Weights in the EUR
02
03
04
05
06
07
08
09
10
97
98
99
00
01
02
03
04
05
06
07
08
09
10
15
4
7
1
10
16
7
16
4
Deutsche Bank
Food & beverages

Alcohol & tobacco
Clothing & footwear
Housing & household services
Furniture & household goods
Health
Transport
Communication
Recreation & culture
Education
Restaurants & hotels
Other goods & services
Contents
Inflation Linked Bonds

Real Yield and Breakeven Inflation and Inflation Protection
Indexation and Breakeven Inflation
Risk Measures, EM Sovereign Linkers, Seasonality and US TIPS
UK Index Linked Gilts, EUR Sovereign and other Important Markets
ILB coupon frequency and settlement characteristics
Deutsche Bank
Contents
3.1
Inflation Bonds Linkers

Inflation Linked Bonds (also known as
inflation indexed bonds) or Linkers.
These are Treasury bonds designed
to cancel the capital eroding effects
of inflation. Called TIPS (Treasury
Inflation Protection Securities) in the
US, their interest rate remains fixed but
the principal is adjusted to match
changes in a price index.
For example:
A vanilla fixed rate bond pays a fixed
coupon and redeems at 100
Interest Paid = Fixed Rate *
Constant
Notional (e.g. 5% * 100 = 5)
Redemption = Constant Notional
(e.g. 100)
Deutsche Bank
A Canadian style Linker pays a real

coupon and redeems at 100 in real
terms
Index Ratio = CPI Index on
Payment Date / CPI Index on
Issue Date
Interest Paid = Fixed Rate * Inflated
Notional
= Fixed Rate * Notional * Index
Ratio (e.g. 2% * 100 * 1.5 = 3)
Redemption = 100 * Index Ratio
(e.g. 100 * 1.5 = 150)
Fig. 1: Expand
Vanilla Fixed Rate Bond versus Inflation
Linked Bond

Real
Nominal
10%
Coupon
Principal
9%
160%
140%
8%
120%
7%
6%
100%
5%
80%
4%
60%
3%
40%
2%
20%
1%
0%
Year 1
0
2
10
Some ILBs (like US TIPS or OATei/i)

have a deflation floor, meaning a
principal repayment of minimum par is
guaranteed by the issuer
Contents
3.2
Real Yield and Breakeven Inflation and

Inflation Protection
Real Yield and Breakeven Inflation
Components of nominal interest rate:
Real yield
Expected Inflation
Risk Premium
Liquidity Premium
Issuing nominals means investors need
compensation for inflation uncertainty.
Inflation Protection
With positive inflation, the ILBs cash
flows will increase over time to secure
the investors purchasing power.
Compared to a nominal bond early
coupon payments will tend to be lower,
and the final repayment will tend to be
higher.
Linkers save issuers the risk premium

by providing certainty about real cash
flows in the future i.e. their increase
in purchasing power is locked in.
(figure 1)
The examples below assume an annual

coupon and inflation at 2%. (figures 2
and 3)
Fig. 1: Expand
Components of Nominal Yield
Fig. 2: Expand
Nominal cash flows

9%
8%
Nominal Yield
7%
6%
5%
4%
3%
Ination
Expectations
Real Yield
2%
Risk
Premium
Liquidity
Premium
1%
0%
Index Linked Bond

1
Breakeven Rate
4
Deutsche Bank
10
Coupon Linker (2%)

Coupon Conventional Bond (4%)
Fig. 3: Expand
Real cash flows (purchasing power
of the CFs)
Notional Conventional (rhs)

Notional Linker (rhs)
Coupon Linker (2%)

Coupon Conventional Bond (4%)
Notional Conventional (rhs)

Notional Linker (rhs)
14
140
12
120
12
120
10
100
10
100
80
80
60
60
40
40
20
20
2
0
0
1
10
notl
0
1
10
notl
Contents
3.3
Indexation and Breakeven Inflation
Deutsche Bank

103
102
101
ILBs value is often expressed in terms

of inflation rather than in terms of real
yields by considering the difference in
yield between nominal and real bonds.
98
97
96
Jan 04
Jun 04
Nov 04
Apr 05
Sep 05
Feb 06
Jul 06
Fig. 2: Expand
BEI nominal yield real yield
Real Yield
Nominal Yield
6.0 %
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
BTPei 35
OATei 40
OATei 32
BTPei 23
GGBei 25
BTPei 17
OATei 20
DBRei 16
BTPei 14
OATei 15
Breakeven Ination
BTPei 12
OBLei 13
In practice, the market looks at simple

yield spreads (figure 2).
99
BTPei 10
BEI (Breakeven Inflation) is the inflation

rate that equates the expected
return of an ILB and a comparable
nominal bond; i.e. if actual inflation
until maturity exceeds BEI, linkers
outperform nominals.
100
OATei 12
Indexation: the Canadian model is

now the benchmark, adopted among
others by TIPS, EUR ILBs and new
UKTi (figure 1)
Problem: CPI only monthly and
published with a delay
The price factor used to inflation
adjust cash flows, the Daily
Inflation Reference (DIR), is a linear
interpolation of
the two monthly values of the official
price index three months earlier and
two months earlier, e.g.:

The DIR for 1 June is the
official CPI March (released
mid-April)

The DIR for 1 July is the
official CPI April (released
mid-May)

The DIR for 23 June is
: CPI(Mar) + 22/30 *
[CPI(Apr) CPI(Mar)]
Fig. 1: Expand
Indexation
BTPei 08
Price index: typically a non-seasonally

adjusted, official consumer price index
Breakeven Inflation
Canadian style linkers are quoted in
real terms and the real price (P) - real
yield (r) relationship is equivalent to
that of a conventional bond (c: coupon):
BTANei 10
Indexation
To offer inflation protection you need
to: (i) choose a price index, (ii) define
precise linking rules.
Contents
3.4
Risk Measures, EM Sovereign Linkers,

Seasonality and US TIPS
Risk Measures
The concepts of duration and
convexity can be applied to linkers
in the same way as for conventional
bonds
But in the case of linkers, duration
describes the sensitivity of the price
to a change in the real rate
Linkers have a higher duration than
same maturity conventionals
Convexity rises exponentially with
duration, for the same maturity ILBs
have a higher convexity than
nominals
EM Sovereign Linker Markets
Most Latin American inflation
markets have long histories; Brazil is
by far the largest market, suppression
of investment restrictions in 2006
spurred international demand
Chile, Colombia & Uruguay also
issue ILB
Israel has a large linker market
(USD27bn market value)
More recently South Africa, Poland,
Turkey (2007) and South Korea (2007)
Deutsche Bank
Seasonality
Seasonal movements in price indices
mean that inflation accrual is not
linear
Quoted real yields of ILB adjust to the
changing inflation uplift
real yields & BEI exhibit
seasonal patterns
detecting the seasonal
pattern in prices is important
for valuing ILBs
Estimation of seasonal factors is not
without difficulties, especially in the
euro area where there is instability
There is no consensus on their
precise value
Fig. 1: Expand
US TIPS total outstanding market value
Source: US Treasury
700
USDbn
600
500
400
300
200
100
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
US TIPS
The US sovereign linker market is the
largest globally with total market
value in excess of USD700bn (figure 1)
TIPS were first issued in 1997; in
recent years, there have been two
5y, two 20y and four 10y auctions per
year; in February 2010 30y TIPS were
reintroduced, replacing the 20y
Maturities range from 1y to 30y
Contents
3.5
UK Index Linked Gilts, EUR Sovereign Linkers,

and other Important Markets
UK Index Linked Gilts
The UK linker market is the oldest in
Europe (first issuance 1981)
Total market value exceeds
GBP270bn and more than 20% of
sovereign debt is linked to inflation
Traditionally bonds have an 8M
indexation lag, but since Sep 2005 all
new issues follow the 3M lag model;
UKTi have no deflation floor
Issuance has been weighted towards
the long end
Maturities range from 1Y to 50Y,
with issues available on all main
curve points (figure 1)
EUR Sovereign Linkers

Euro area sovereign inflation-linked
bond (ILB) markets are expanding
rapidly with the total market value
exceeding EUR320bn today
France, Italy, Germany & Greece
issue ILBs
Italian, German and Greek ILBs are
linked to euro area inflation; France
issues both bonds linked to EUR
inflation and bonds linked to FRF
inflation
Maturities range from 1Y to 32Y, with
issues available on all main points on
the curve (figures 2 and 3)
Other important markets include

Australia, Canada and Sweden
AUD: govt suspended issuance in
2003, but started again in 2009.
Strong liability related demand from
PF and insurance companies
Sweden: linkers account for almost
30% of the total government bond
market, a higher share than in any
other industrial market
Fig. 1: Expand
UK Total Outstanding Market Value
Fig. 2: Expand
EUR Sovereign Linker Issuance
Fig. 3: Expand
Sovereign Linkers, Outstanding Volume
Source: UK DMO
Source: National Treasury
Source: National Treasury
30
Total Outstanding 350

EURbn
300
25
250
210
20
200
160
15
150
15
10
100
10
50
Deutsche Bank
2010
2003
2004
2005
2006
2007
2008
2009
2010
2041
2009
2039
2008
2037
2007
2035
2006
2033
2005
0
2031
2004
2029
2003
20
2027
2002
25
2025
2001
30
2023
60
EURbn
35
2021
110
40
Fr (FRCPIxt)
Italy
2019
260
Linker Issuance
EURbn
Germany
France
Greece
2017
35
2015
USDbn
DE
GR
2013
310
FR
IT
EUR (rhs)
2011
Contents
3.6
ILB coupon frequency and settlement

characteristics
Most ILBs have coupon frequency and settlement characteristics in line with
the nominal market
Price index
BBG
Index lag
Deflation floor
Coupon
US
CPI-U
CPURNSA
3M
YES
semi-ann
UK
RPI
UKRPI
8M/3M
NO
semi-ann
CPI x tob, FR
FRCPXTOB
3M
YES
annual
HICP x tob, EMU
CPTFEMU
3M
YES
annual
IT
HICP x tob, EMU
CPTFEMU
3M
YES
semi-ann
JP
CPI x fresh food
JCPNJGBI
3M
NO
semi-ann
SE
CPI
SWCPI
3M
YES (new ILB)
annual
CA
CPI
CACPI
3M
NO
semi-ann
GR
HICP x tob, EMU
CPTFEMU
3M
YES
annual
DE
HICP x tob, EMU
CPTFEMU
3M
YES
annual
AU
CPI quarterly
ACIF
6M
YES
quarterly
FR
Deutsche Bank
Contents
Inflation Swaps
ILS Swaps and Markets
UK Swaps, Corporate Linkers and US Swaps
ILS Indexation
ILS Pension Fund Demand
Deutsche Bank
Contents
4.1
Inflation Swaps
ILS Swaps
Inflation Linked Swaps (ILS) a pure
inflation product as opposed to a real
rate product
What is an Inflation Swap?
The cash-flows
Receive Compounded Inflation from
Start to Maturity: pay one cash-flow
CPIt/CPI0 -1
Pay a known Fixed cash-flow at
Maturity
(1 + X%)^t
ILS Markets
The most liquid ILS are typically those
linked to the same price index as the
inflation-linked government bonds of
the corresponding market (US CPI-U,
EUR HICP ex-tobacco, French CPI ex
tobacco, UK RPI).
For the major markets, ZC ILS are
usually quoted for tenors out to 30
years, sometimes 50 years.
Fig. 1: Expand
Inflation Swaps
(1+BEI)N1
Fixed
Client
Floating
CPI(N)
CPI(0)
What is the break-even rate?

Receive Compounded Inflation from
Start to Maturity: pay one cash-flow
CPIt/CPI0 -1
Pay a known Fixed cash-flow at
Maturity
(1 + X%)^t
Deutsche Bank
Contents
4.2
Inflation Swaps
UK Swaps, Corporate Linkers and US Swaps

UK Swaps and Corporate Linkers
Non-sovereign inflation supply in bonds
& swaps has grown rapidly in the UK in
particular 2006 and H107
Market
Price
Index
Lag
CPI Fixing
US
CPI-U
3M
Interpolated
Euro area
HICP ex
tobacco
3M
Straight
France
CPI ex
tobacco
3M
Interpolated
UK
RPI
2M
Straight
US Swaps
The inflation swap market has
developed rapidly from 2004, but
remains less liquid than its European
counterparts
A lack of natural inflation swap supply
translates into structural richness in
swap BEI vs bond BEI and wide linker
ASW discounts
Fig. 1: Expand
Bond Breakevens vs Swap Breakevens

USCPI ZC swap rates

TIPS-implied ZC B/E
3.1
Fig. 2: Expand
Measures of Relative Value: ASW
Spread and Z-spread

US Linker Z-spread discount

US Linker ASW discount
35
30
2.9
25
2.7
20
15
2.5
10
2.3
1.9
0
Deutsche Bank
10
15
20
25
30
TII Apr 13
TII Jul 13
TII Jan 14
TII Apr 14
TII Jul 14
TII Jan 15
TII Apr 15
TII Jul 15
TII Jan 16
TII Jul 16
TII Jan 17
TII Jul 17
TII Jan 18
TII Jul 18
TII Jan 19
TII Jul 19
TII Jan 20
TII Jul 20
TII Jan 21
TII Jan 25
TII Jan 26
TII Jan 27
TII Jan 28
TII Apr 28
TII Jan 29
TII Apr 29
TII Apr 32
TII Feb 40
TII Feb 41
2.1
Contents
4.3
Inflation Swaps
ILS Indexation
ILS Indexation
For FRCPIxt & US CPI, the indexation
lag convention is the same as for the
corresponding inflation-linked bond
markets
Strong demand has led to a low
level of real interest rates, lock in
low financing costs
PFI projects with inflation component
(usually bonds, but typically
transformed into ASW)
Credit wrapping allowed corporates
to issue highly rated debt which
is more appealing to institutional
investors
Deutsche Bank
But has fallen significantly during the

credit crisis
Main sources: regulated utilities, PFIs,
property leases, railway companies,
retailers, supranationals
Alternative supply has led to two-way
swap market and narrow swap-bond
B/E spread, but swap richness has
increased again during the crisis
Contents
4.4
Inflation Swaps
ILS Pensions Fund Demand

ILS Pension Fund demand
In the UK, pension indexation to RPI
(LPI) is more explicit than elsewhere
and the pension industry is larger
than in other European countries
Accounting rules (Financial
Reporting Standard 17) have
encouraged pension funds to match
their indexed liabilities more closely
As a result, demand growth from
pension funds and life insurers has
outstripped supply leading to low
real yields and expensive BEI at the
long-end of the curve But has fallen
significantly during the credit crisis
Long-term investors own the
majority of ILB as a hedge for
their real liabilities
All public and part of private sector
pension liabilities will be linked to CPI
(instead of RPI) from fiscal year
2011/12 future issuance of CPI
linked Gilts looks possible
Fig. 1: Expand
Real Yields
Fig. 3: Expand
UK Non-sovereign Inflation Supply

US
UK

FRF
Other

Rail

Utility
2.5 Real Yields

2.0
1.5
1.0
0.5
0
-0.5
-1.0
-1.5
-2.0
-2.5
-3.0
2009
4,000
GBPm
3,500
3,000
2,500
2,000
1,500
1,000
500
Maturity
2017
2025
2034
2042
2050
2058
0
Q305
Q306
Q307
Q308
Q309
Q310
Fig. 2: Expand
UK Non-sovereign Inflation Supply

UK Non-sovereign inflation supply

10,000
9,000
Issuance
GBPm
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
2001
Deutsche Bank
2002
2003
2004
2005
2006
2007
2008
2009
2010
Contents
Assessing Relative Value

Linker Asset Swap and the Leverage Effect
5 Sources of Asset Swap Difference
What is the Fair Price for Inflation Protection?
Fair Credit Spread of Inflation Linked Bonds
Hedge with Bonds or Swaps
Summary
Deutsche Bank
Contents
5.1
Linker Asset Swaps and the Leverage Effect

Linker Asset Swap
Investor buys an Inflation Bond
Investor agrees to pay away all the
cash-flows (P+I) from the bond
Investor receives in return Libor +
x% until maturity as well as a
principal payment
The increasing credit exposure,
and thereby return, on a linker
asset swap generates significant
outperformance
Daragh McDevitt,
Global Head of Inflation Structuring
The Leverage Effect

Sophisticated investors may not
be able to borrow to buy additional
nominal bonds due to constraints,
hence are willing to give up some of
their excess return
Fig. 1: Expand
Linker Asset Swap
Inated Notional
CPI
Why is this important?

Sovereign default is currently very real
possibility like for like exposures
need to be carefully assessed for fair
value some investors have increased
credit risk for very little reward
CPI
Linker
Some investors just like the pick-up

over equivalent tenor nominal bonds
on asset swap (figure 2)
For example
This is how we expect a Linker to
increase in the Eurozone over time
Inated Notional
Investor
Libor + X
Notional
Fig. 2: Expand
The Leverage Effect

Inflation
Libor
350
Notional
300
250
200
Increasing Credit Exposure
150
100
Constant Swap Notional
50
0
Years
Deutsche Bank
10
15
20
25
30
35
40
45
50
Contents
5.2

PV01 difference
Linkers have a higher duration
Swap richness
The spread between inflation-linked
swaps and implied bond break-evens
gives rise to different asset swap
levels for linkers and nominals
It also usually tells the story of swap
supply and demand
Seasonality
See the section on page 3.4
Credit / Liquidity
Mis-priced credit cost leading to
value for issuers
Tax
Favourable deferrals for issuers
encourage supply
Deutsche Bank
The difference between a nominal

asset swap and a Linker Asset Swap
of the same maturity is a function of
the larger credit exposure, the term
structure of credit and the swap
richness
Of these comparative measures

richness is the true measure
Stephane Salas,
Global Head of Inflation Trading
For example
20 bps richness results in an additional
28 bps on asset swap a 40% increase
Fig. 1:
Measures of Relative Value
Adjusts for
Dirty Price
Accounts
for Cashflow
Pattern
Accounts for
Term Structure
of Credit
Fair Value
Discounting
Par par ASW

Net Proceeds
ASW
Z spread
Richness
Contents
5.3
What is the Fair Price for Inflation Protection?

What is the Fair Price for Inflation
Protection?
Inflation Breakeven is not equal to
market inflation expectations but is a
factor of
Inflation expectations
Risk Premium
Liquidity Premium
Inflation expectations over the very
long run are hard to judge but tend to
be based on current economic policy
ECB target rate is under, but close
to 2%
Deutsche Bank
Risk Premium includes

Potential change in monetary policy
target (e.g. 4% plus or minus 1%
instead of under 2%)
Abandonment of monetary policy
in favour of employment or
currency board
EUR breakup, expansion or
succession
Asymmetric elasticity of inflation:
wages are easier to raise than to cut
Liquidity premium includes
Relative demand and supply for
inflation bonds v nominal bonds
Balance sheet costs of holding
inflation bonds to recycle inflation
Opportunity cost of capital for cash
used to hedge inflation
The biggest mistake people make

with inflation-linked bonds is
thinking that the breakeven inflation
is the markets expected inflation
rate. It is not and should not be.
The breakeven includes what the
market expects inflation to be
and the major portion of the risk
premium that you should find in
the nominal market, and the
liquidity premium
Markus Heider,
Global Head of Inflation Research
Contents
5.4
Fair Credit Spread of Inflation Linked Bonds

Fair Credit Spread of Inflation
Linked Bonds
Issuing Linkers equates to borrowing
more over time in nominal terms i.e. it
can be thought of as a set of forward
starting bonds
Forward starting bonds = greater
credit risk
Two components to fair price:
The issuers current credit spread for
the maturity of the bond
Forward credit spreads for each of
the forward starting borrowings i.e.
forward credit spreads
Fig. 1: Expand
Linker as a Series of Forward
Starting Bonds
Fig. 2: Expand
Creating a synthetic 30-year old
Nominal Bond
Initial Principal Amount

Fwd Borrowing Year 2
140

EUR 100mm
30y @ 150bp
Borrowed Amount
120
100
EUR 25mm
80
EUR 25mm
60
EUR 50mm
20y @ 130bp
10y @ 100bp
30y accreting @ 175bp
40
20
0
Years
10
A simple point, but investors may not

recognise and price this correctly
Deutsche Bank
Contents
5.5

The Question is
Traditionally, many investors have
primarily considered inflation-linked
bonds to hedge exposure
However, a more modern approach is:
Bonds can be cheaper or more
expensive than swaps
Buy the cheapest asset
Hedge the inflation with swaps
Opportunistically switch
between assets
This also gives a lot more flexibility to
hedge the desired cash flows, since at
the long-end there are only relatively
few bonds outstanding (and liquidity
can be better as well)
The Bond Universe

Value within the UK for example
Figures 3 and 4 on the right depict the
value that can be created by switching
between similar maturity nominal and
inflation linked bonds.
Figure 2 below depicts the value in
switching between short and long
maturity linkers.
Fig. 3: Expand
PV Gain of UKTi27 over the UKT27
Past performance is not a reliable indicator of future performance

Switch in
Switch out
8
In terms of trading capability, how

does this work?
We should always be free to switch
between UK Bonds and UK Linkers
PV Gain (%)
2
0
01/10
03/10
05/10
07/10
09/10
11/10
01/11
Fig. 1: Expand
Swap Inflation Price Bond Inflation Price
Fig. 2 : Expand
PV Gain of UKTi40 over the UKTi27
Fig. 4: Expand
PV Gain of UKTi40 over the UKT40



UK
France (French CPI)
France (Euro CPI)
Italy
Germany
50
Switch in
Switch out
10
40
Switch in
Switch out
10
PV Gain (%)
03/11
PV Gain (%)
30
20
10
0
-10
-20
0
2010
2016
2021
2027
2032
2038
2043
2049
Deutsche Bank
2054
2060
01/10
03/10
05/10
07/10
09/10
11/10
01/11
03/11
01/10
03/10
05/10
07/10
09/10
11/10
01/11
03/11
Contents
5.6
Summary
To sum up
Given the displacement between
inflation and nominal markets, there
are opportunities for arbitrage
Asset swap spreads on linkers
represent a premium for credit that
is hard to price, and when coupled
with demand/supply imbalances and
higher duration, they offer a pickup
to nominals for the same underlying
issuer
Switching between equivalent risk
sovereigns/supra sovereigns can
often, driven by dynamics of the
cross currency swaps market,
provide additional yield pick-ups
There isnt one risk free curve,
there are 100, 150, 200 the key is
when do you pick the fruit, when
is the bond cheap enough?
Daragh McDevitt,
Global Head of Inflation Structuring
Deutsche Bank
These displacements can be

assessed by a variety of metrics
The value of switching is evident
from the incremental excess pickup
that is generated by selling the
costlier asset to buy the cheapest
asset from time to time
Used as a systematic strategy
this can yield substantial returns
over medium term horizons
These represent incredible
opportunities for asset-heavy
investors, and the markets will
likely normalize with time, hence
it is important to act quickly
there are incredible opportunities
for asset-heavy investorsit is
important to act quickly
Haroon Sana,
Global Head of Rates Sales
Contents
Inflation Options
Inflation Options
Who are the major players in the options market?
Option Products
What are the trading opportunities?
Option Strategies
Creating Optimal Hedges
Deutsche Bank
Contents
6.1
Inflation Options
Inflation Options
Fig. 2: Expand
NY Options Volumes
Source: Tullett Prebon
Source: Tullett Prebon

1,800
1,600
Volumes
(millions)
1,400
5,000
1,200
4,000
800
3,000
600
2,000
03/11
01/11
11/10
09/10
07/10
05/10
03/10
01/10
11/09
09/09
07/09
03/11
01/11
11/10
09/10
07/10
05/10
03/10
01/10
11/09
09/09
07/09
0
05/09
200
05/09
400
1,000
03/09
6,000
Volumes
(millions)
01/09
7,000
03/09
Long term growth looks set to

continue at this explosive rate, which
is clearly indicative of its importance
to clients and represents a substantial
opportunity to DB as intermediary
between buyers and sellers of inflation.
Fig. 1: Expand
London Options Volumes
01/09
A relatively new market, inflation

options traded between Europe and
the US have doubled every year since
trading started in inflation swaps in
2002/2003. 2010 saw a particular
growth spurt.
Interbank volumes reached 50bn in

2010, up from 13bn in 2009, and just
1bn in 2005.
Deutsche Bank
Contents
6.2
Inflation Options
Who are the major players in the Options market?

The market is becoming more and
more complex as sophisticated new
players such as hedge funds, liability
driven investors, and non-life insurance
practitioners are added to the mix.
Any client:
holding a bond portfolio
subject to tail inflation high or low
who has revenues or liabilities that
are indexed to inflation
is exposed to inflation risk
Asset Manager
Monetize
Embedded
Floors
Buy Deation
Protection
Hedge LPI
Liabilities
Ination Options
Market
Insurance Company
Directional/
RV Trades
Hedge Fund
Pension Fund
Hedge LPI
Revenues
Real Estate Investor
Expand
Deutsche Bank
Contents
6.3
Inflation Options
Options products
Year on Year cap/floor
YoY floorlet : Max [ K - YoYt , 0 ]
With YoYt = It /It-1 - 1
A 5 year 0% YoY floor costs 80c
or 18bp p.a.
Demand from retail notes >> Supply
from premium sellers
Zero Coupon cap/floor
ZC floor: Max [ (1+K)^t - It /I0 , 0 ]
A 10 year 0% ZC floor costs 55c
Supply from linkers and asset swaps
>> Demand from deflation hedgers
Limited Price Index (LPI)
LPIt = LPIt-1 * { 1 + max [ min [ YoYt ,
5% ] , 0% ] }
Inflation observed annually, collared,
compounded and paid at maturity
Demand from LDI funds >> Supply
from real estate investors
Fig. 1: Expand
5y 0% YoY floor HICPxT
Fig. 3: Expand
Limited Price Index (LPI)

400
6.0
Price (bps)
350
5.0
300
4.0
250
3.0
200
150
2.0
100
1.0
50
0
08/06
05/07
02/08
11/08
08/09
05/10
02/11
Fig. 2: Expand
10y 0% ZC floor HICPxT
YoY Ination -2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
Fig. 4: Expand
DB Inflation pages: DBII

160
140
120
100
80
60
40
20
0
04/09
Deutsche Bank
10/09
04/10
10/10
04/11
Contents
6.4
Inflation Options
What are the trading opportunities?

LPI Collars represents a great inflationhedging alternative
Inflation risk for Pension funds and
other liability-driven investors is big,
20 30% of scheme risk.
Breakevens are deemed expensive: if,
for example, breakeven is 3.7% and
the scheme expected inflation of 2.8%,
hedging loses value (figure 1).
Whats the solution?
Cover inflation risk by creating an
inflation collar
Pay LPI
Receive RPI
The catalyst that makes this trade
work is inflation at above 5% this
5% strike is currently lower than
spot inflation a change from the
last five years
Nicolas Tabardel,
Global Head of Inflation Volatility
and Exotics
Expert historical perspective

Markus Heider, responsible for
European inflation research at DB
Global Markets Research, provides
a useful long term perspective: this
graph shows how the volatility we have
seen in the last three years is nothing
compared to the last 200 years. In the
long run, inflation is a very volatile
entity, which means risk and therefore,
opportunity.
The relative stability weve seen in the
last 20 years can very quickly change
Significant risk factors currently include
governments with unsustainable
deficits and globalisation; the need
to hedge inflation risk is becoming
increasingly relevant
Fig. 1: Expand
Assumed Constant Year on Year
Inflation Return

RPI ZC Swap
100% LPI Collar
40
Payo
30
20
10
0
-10
30y Breakeven
3.63%
-20
-30
-4% -3% -2% -1%
0%
1%
2%
3%
4%
5%
6%
7%
8%
Fig. 2: Expand
Consumer price inflation, y/y%, 11-yr MA
Source: EH Net

UK
US
15
10
10
1
0
-5
-10
1750
1775
1800
1825
1850
1875
1900
1925
1950
1975
2000
1. US war of Independence
2. Napoleonic Wars deficit monetised
3. 1st Industrial Revolution: productivity-led deflation
4. US Civil War
5. 2nd Industrial Revolution: productivity rebounds; gold finds
6. Fiscal monetisation during WWI
7. Great Depression
8. Fiscal monetisation during WWII
9. Fiscal monetisation during Vietnam War; oil shocks
10. Volcker clamps down on inflation
Deutsche Bank
Contents
6.4
Inflation Options
Market vs Economist Expectations

UK RPI future inflation: the market
in the long term is pricing much
more downside risk than upside
risk. In the UK, the risks of inflation
overshooting are much higher than
them undershooting. This is contrary to
what we see in other markets.
In Europe and the US, there is more
balance; caps are becoming more
much more expensive than floors.
Consensus economist predictions
indicate that market implied volatility
is too high; tails are too fat and the
skew is too deep. Caps have no natural
supply in Europe or the US so the tail
risk is always expensive (figure 1).
In Europe, volatility is too high, tails are

too fat, and the skew is too steep.
Fig. 1: Expand
Skew prices floors higher than caps
What does this mean?

Selling volatility now is a good idea
The skew was pricing floors higher
than caps; the skew is now symmetric
(figure 2).

SPF prob distribution for 5y infl forecast
Market Implied Probability from EUR YoY caps/floors
0.4
0.3
2
0.2
0.1
We expect this trend to continue,

so that by the end of 2011, caps
become more expensive than floors,
better reflecting fundamentals
Stephane Salas,
Global Head of Inflation Trading
0
<0
0 - 0.5
1.0 - 1.5
2.0 - 2.5
3.0 - 3.5
>4
1. Deflation risk is overpriced

2. Consensus economist predictions imply market implied volatility is too high
3. Fat Tails
Fig. 2: Expand
Ratio of market implied probability vs.
Economist Expectations
40
Value in selling wings
distribution i.e. far out of
the money caps and oor
30
20
10
0
<0
Deutsche Bank
0 - 0.5
1.0 - 1.5
2.0 - 2.5
3.0 - 3.5
>4
Contents
6.5
Inflation Options
Option Strategies
Collars (figure 1)
Sell Floor
Buy Cap
Fig. 1: Expand
Long (0,3) Collar
8
Strangles (figure 2)
Sell OTM Floor
Sell OTM Cap
Straddles
Sell Floor and Cap at same strike
-2
Range Accruals
Pays N/12 * Fixed Rate, Annual
N = No. of months 1% < YoY EUR
HICP <3%
5y Note with DB funding, Fixed
Rate = 3.40%
Payo (%)
4
2
0
-4
-6
YoY Ination Print (%) -5 -4 -3 -2 -1 0
9 10
Fig. 2: Expand
Short (0,3) Strangle
1
Payo (%)
0
-1
-2
-3
-4
-5
YoY Ination Print (%) -5 -4 -3 -2 -1
Deutsche Bank
Contents
6.6
Inflation Options
Creating Optimal Hedges
Building Blocks
Selling a 0% YoY floor
Selling a 1x / 2x cap spread
Fig. 1: Expand
Sell 0% floor, But 1x/2x Cap Spread
3.0
Premiums
5Y 0% floor generates 160bps
5Y 2% cap costs 260bps
5Y 5% cap costs 100bps
2.5
Using these components

Zero cost and benefits from inflation
between 2% and 8%
-1.0
Payo (%)
1.5
1.0
0.5
0.0
-0.5
-1.5
YoY Ination Print (%) -2
-1
10
Covered Linker Switches

Sell nominal bond
Buy Linker
Sell year on year caps @ 2.5% on
coupons and principal
OATei15
OATei22
OATei32
Covered Caps
(%)
(%)
(%)
Upfront Premium
1.59%
3.95%
11.39%
Running Premium
(annual, 30/360)
0.40%
0.42%
0.73%
Real Yield Pick-Up
0.32%
0.35%
0.43%
Effective
Breakeven Rate for
outperformance of
nominals
1.25%
1.44%
2.67%
Deutsche Bank
Contents
Deflation Tail Risk

Deflation Tail Risk: DB 5 Year Note
Deutsche Bank
Contents
7.1
Deflation Tail Risk
Deflation tail risk: DB 5 Year Note
Deflation tail risk: DB 5 Year Note

Investors can take advantage of the
substantial dislocations in the Inflation
Option Market by selling deep out of
the money Inflation Floors.
A 5 year DB Deflation Note provides
a return over 4% per annum if YoY
Euro-zone Inflation prints above -2.0%,
providing 190 bps of pick up over 5y
EUR Swap Rates.
Euro-zone inflation printing below
-2.0% is an unprecedented event, never
seen in ANY Euro economy.
The below note details indicative
terms and compelling reasons for
investors to take on this risk for above
market returns. The last section looks
at variations in USD, GBP in addition
to alternate ways of monetizing the
opportunity in EURs
The underlying market dislocations
are unsustainable and will soon be
removed by exogenous liquidity
provided by real money accounts.
This opportunity represents clear value.
Deutsche Bank
DB Short Deflation Risk Note

Indicative Trade Terms
Indicatitive Terms
Currency
EUR
Format
DB Funded Note
Maturity
5 years
Issue Price
100.00
Re-Offer
99.00
Redemption
121 - Floor(T), minimum

return of 0.00
Reference Rates
5y Inflation B/E
5y Swap Rate
Max IRR
1.735%
2.16%
4.065%
Where
FLOOR(T)
121 * Sum[ Floor(t) ] for

t = 1,2,3,4,5
Floor(t)
12 * Max (Floor Strike - YoY

Inflation, 0%)
Floor Strike
-2.00%
YoY Inflation
CPI(t) / CPI(t-1) -1
Where CPI(t) is the EUR
HICP ex Tobacco Index
(CPTFEMU Index) 3m
prior to Observation Date t
CPI(t-1) is the EUR HICP ex
Tobacco Index (CPTFEMU
Index) 15m prior to
Observation Date t
Contents
Case Study: Zero-Coupon Option Trade
Deutsche Bank
Contents
8.1
Case Study
Case Study: Zero-Coupon Option Trade
During the first six months of 2010,

a Toronto-based insurer purchased
deflation protection worth $21.539
billion in notional, paying $173.7 million
in premium. The 10-year zero-coupon
0% options were denominated in
dollars, euros and sterling, and were
executed by Deutsche Bank and Citi.
The other side of the trade was largely
taken by California-based fixed-income
manager Pimco, which reported it had
sold more than $8 billion of 10-year
zero-coupon 0% inflation floors in a
filing dated August 27. The floors were
sold in return for more than $70 million
in premium, with Deutsche and Citi as
counterparties.
The transaction made perfect sense
for both participants. For the insurer,
the 0% floors acted as a hedge against
deflation and the impact that would
have on its equity portfolio. At the
same time, Pimco was able to cash in
on 0% inflation floors embedded in its
sizable portfolio of Treasury inflationprotected securities (Tips). Dealers say
the headlines generated by the trade
had a positive impact on the market,
encouraging other clients to express
Deutsche Bank
their views on the direction of inflation

by buying or selling zero-coupon
options.
Daragh McDevitt, DB Global Head of
Inflation Structuring said, It sparked
interest because you have very
intelligent investors on both sides who
are taking opposite sides of the trade.
The transaction made perfect sense

for both participants. For the insurer,
the 0% floors acted as a hedge against
deflation and the impact that would
have on its equity portfolio. At the
same time, Pimco was able to cash in
on 0% inflation floors embedded in its
sizable portfolio of Treasury inflationprotected securities.
Since Q2, 2010, quantitative easing

has encouraged more clients to sell
implied inflation volatility at levels that
look expensive. In particular, many
market players have looked to play
inflation volatility versus interest rate
volatility for example, by buying
interest rate caps and selling inflation
caps at similar strikes. Weve seen a
lot of clients coming in on the same
side as Pimco, viewing the probability
of deflation priced in by these options
to be inflated. They are either selling
the options embedded in their bond
portfolios, selling the options outright
or entering into some kind of interest
rate options strategy, says McDevitt.
Contents
Further Reading
Deutsche Bank
Contents
9.1
Further Reading
Further Reading
Weekly Inflation Research update
Change in breakevens, US & UK

GBP
PUBLISHED BY
Macro
Strategy Update
DB Inflation Report
USD
30
Weekly Inflation Update
25
1W change in B EI
20
Global Markets Research
Macro
Global
7 October 2011
carry adjusted
15
10
5
0
-5
-10
Economics: This weeks PPI data point to further upward pressure on UK and
euro area consumer core inflation in the coming months. Business survey price
balances have continued to fall in September however, which is consistent with
the view that CPI inflation will slow in 2012.
Global: 10y EUR real rates look too high relative to USD against the recent data
divergence. We prefer long-end TIPS and UKTi B/Es over OATei.
2y
5y
EUR: The ongoing deterioration in economic data remains challenging for B/Es. In
RV, we prefer the 10y sector and the DBRei-20 in particular.
USD: Forward TIPS B/Es have diverged from survey-based measures of inflation
expectations, although declines may be exaggerated by liquidity factors.
AUD: In our view, the market is underpricing inflation risk over the short term, with
the gap between RBA inflation expectations and breakevens extremely wide. Our
preferred trade is long the belly in 2y/5y/10y ZCS B/E butterfly.
Asia: Inflation in Thailand & South Korea fell more than expected in September,
supporting our expectations of no policy rate change at the next CB meeting.
JUNE | 2011
10y
30y
2y
5y
10y
30y
Change in breakevens, EUR & FRF

EUR
FRF
20
15
1W change in B EI
carry adjusted
10
GBP: While real yield valuations are challenging, the scheduled new 50y linker
issue should look attractive relative to nominal gilts (in B/E and ASW), RPI swaps
and B/Es in other markets.
CLEAR PATH ANALYSIS IN PARTNERSHIP WITH
Inflation Big Picture Study
Global
Global Markets Research
Inflation Hedging for Institutional

Investors
Examining dynamic asset allocation
strategies for high inflation scenarios
and the effect of financial market
changes on inflation hedging
instruments.
5
0
-5
-10
2y
5y
10y
30y
2y
5y
10y
20y
1 March 2011
Global Macro Issues

Issues in Inflation
Economics
Research Team
Markus Heider
(+44) 20 754-52167
markus.heider@db.com
Abstract
The uncertainty about the longer-term inflation outlook has risen substantially since
the onset of the financial crisis in 2008. After 15 years or more of low and stable
inflation, professional forecasters, investors and indeed central banks themselves
now consider below and above target outcomes as possible, even probable. The
non-standard reaction of economic policy during the crisis, the discussion about
potential changes to monetary policy objectives, the run-up in public debt, but also
apparent changes to the inflation process itself during the Great Moderation as
well as the open inflation implications of structural trends like globalisation all have
contributed to the rise in uncertainty. In this note we look at some of the main
issues surrounding the inflation outlook and conclude that inflation risks for the
coming years seem to be skewed to the upside of central bank targets.
ILB rich/cheap vs nominals

120
Rich (-) / cheap (+) vs nominal curve
100
GBP
DEM
USD
FRF
ITL
80
60
40
20
0
Examining dynamic asset allocation

strategies for high inflation scenarios and
the effect of financial market changes on
inflation hedging instruments
Bond
Yld
-20
BEI 1M fwd
ASW
ASW
discnt
ZC
Rate
Sprd
ZC-BEI
CPI/
RPI
fcst
TII Apr-16
-0.65
1.53
1.51
-18
14
5y
1.87
34
spot
3.8
TII Jan-21
0.05
1.83
1.82
13
31
10y
2.30
48
Dec-11
2.9
TII Feb-41
0.90
2.02
2.02
76
54
30y
2.54
52
Jun-12
1.7
EA HICPxt
DBRei 16
1.69
45
spot
DBRei 20
0.31
1.40
1.36
-48
26
10y
1.84
44
Dec-11
2.7
OATei 40
-0.22
1.44
1.24
2.07
1.16
2.06
109
-65
20
39
30y
5y
2.11
Jun-12
1.8
2.5
FR CPIxt
BTANi-16
0.23
1.52
1.47
21
39
5y
1.88
36
spot
2.2
OATi-19
0.68
1.68
1.65
37
35
10y
2.07
39
Dec-11
2.1
20y
2.18
5y
3.11
OATi-29
2012
2017
2023
2028
2034
2039
2045
US CPI
1.29
2.10
2.09
98
37
Jun-12
1.5
UKTi-16
-1.52
2.86
2.76
-31
15
26
spot
5.2
UKTi-22
-0.37
2.80
2.76
32
10y
3.21
41
Dec-11
5.0
UKTi-40
0.18
3.15
3.14
44
33
30y
3.50
35
Jun-12
3.7
UK RPI
Upcoming data
Mkt
Indicator
Date, GMT
FRF
CPI Sep
12 Oct, 05:30
DEM
CPI Sep
13 Oct, 06:00
EUR
HICP Sep
14 Oct, 09:00
Research Team
Markus Heider
(+44) 20 754-52167
Alex Li
(1) 212 250-5483
alex-g.li@db.com
Vanshree Verma
(+44) 20 754-77583
vanshree.verma@db.com
Deutsche Bank AG/London
Economics
INFLATION
HEDGING FOR
INSTITUTIONAL
INVESTORS
Inflation Markets
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche
Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
MICA(P) 146/04/2011.
Deutsche Bank AG/London

All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche
Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the
firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN
APPENDIX 1. MICA(P) 007/05/2010
Research Inflation Markets Guide

March 2011
ALSO SPONSORED BY
MEDIA PARTNERS
Global Inflation Markets

A guide
Markus Heider
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges
via
i Reuters,
R t
Bloomberg
Bl
b
and
d other
th vendors.
d
D
Data
t iis sourced
d ffrom D
Deutsche
t h B
Bank
k and
d subject
bj t companies.
i
D
Deutsche
t h B
Bank
kd
does and
d seeks
k
to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest
that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment
decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 007/05/2010
Deutsche Bank
Contents
10
Contacts
Deutsche Bank
Contents
10.1
Contacts
Contacts Deutsche Bank Global Inflation Team
Sales
Structuring
Trading
Haroon Sana
Haroon.Sana@db.com
+44 20 754 73671
Daragh McDevitt
Daragh.McDevitt@db.com
+44 20 754 52750
Stephane Salas
Stephane.Salas@db.com
+44 20 754 78809
Matthew Yencken
Matthew.Yencken@db.com
+31 2 8258 2010
Xavier Avila
Xavier.Avila@db.com
+44 20 754 72731
Nicolas Tabardel
Nicolas.Tabardel@db.com
+44 20 754 55748
Michael Durr
Michael.Durr@db.com
+44 20 754 73671
Michael Parker
Michael.Parker@db.com
+65 68 83 08 88
Allan Levin
Allan.Levin@db.com
+1 212 250 7105
David Martins-da-Silva
David.Martins-da-Silva@db.com
+44 20 754 74159
Josh Heller
Josh.Heller@db.com
+61 2 8258 3619
Katsuya Miyoshi
Katsuya.Miyoshi@db.com
+81 3 5156 6205
Matthew Blackwell
Matthew.Blackwell@db.com
+65 68 83 16 20
Research
Vaughan Harvey
Vaughan.Harvey@db.com
+61 2 8258 1848
Ed Rubin
Ed.Rubin@db.com
+1 212 250 0551
Tai-Zhong Jiang (Tai-Chu)
Tai-Zhong.Jiang@db.com
+81 3 5156 6186
Deutsche Bank
Markus Heider
Markus.Heider@db.com
+44 20 754 2167
Alex Li
Alex-G.Li@db.com
+1 212 250 5483
Integrated trading, structuring

and research
Unlike some of our competitors, Deutsche
Banks inflation trading, structuring and
research professionals work closely together,
combining strategic and technical expertise
with the macro-economic insights so
important with this offering.
Contents
This document is intended for discussion purposes only and does not create any legally binding obligations on the part of Deutsche Bank AG and/or its affiliates (DB). Without limitation, this document does not
constitute an offer, an invitation to offer or a recommendation to enter into any transaction. When making an investment decision, you should rely solely on the final documentation relating to the transaction and
not the summary contained herein. DB is not acting as your financial adviser or in any other fiduciary capacity with respect to this proposed transaction. The transaction(s) or products(s) mentioned herein may not
be appropriate for all investors and before entering into any transaction you should take steps to ensure that you fully understand the transaction and have made an independent assessment of the appropriateness
of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. For general information regarding the nature and risks of the
proposed transaction and types of financial instruments please go to http://www.globalmarkets.db.com/riskdisclosures www.globalmarkets.db.com/riskdisclosures. You should also consider seeking advice from
your own advisers in making this assessment. If you decide to enter into a transaction with DB, you do so in reliance on your own judgment. The information contained in this document is based on material we
believe to be reliable; however, we do not represent that it is accurate, current, complete, or error free. Assumptions, estimates and opinions contained in this document constitute our judgment as of the date of
the document and are subject to change without notice. Any projections are based on a number of assumptions as to market conditions and there can be no guarantee that any projected results will be achieved.
Past performance is not a guarantee of future results. This material was prepared by a Sales or Trading function within DB, and was not produced, reviewed or edited by the Research Department. Any opinions
expressed herein may differ from the opinions expressed by other DB departments including the Research Department. Sales and Trading functions are subject to additional potential conflicts of interest which
the Research Department does not face. DB may engage in transactions in a manner inconsistent with the views discussed herein. DB trades or may trade as principal in the instruments (or related derivatives),
and may have proprietary positions in the instruments (or related derivatives) discussed herein. DB may make a market in the instruments (or related derivatives) discussed herein. Sales and Trading personnel are
compensated in part based on the volume of transactions effected by them. The distribution of this document and availability of these products and services in certain jurisdictions may be restricted by law. You
may not distribute this document, in whole or in part, without our express written permission. DB SPECIFICALLY DISCLAIMS ALL LIABILITY FOR ANY DIRECT, INDIRECT, CONSEQUENTIAL OR OTHER LOSSES
OR DAMAGES INCLUDING LOSS OF PROFITS INCURRED BY YOU OR ANY THIRD PARTY THAT MAY ARISE FROM ANY RELIANCE ON THIS DOCUMENT OR FOR THE RELIABILITY, ACCURACY, COMPLETENESS
OR TIMELINESS THEREOF. DB is authorised under German Banking Law (competent authority: BaFin - Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conduct
of UK business. This document is intended for discussion purposes only. You may not distribute this document, in whole or in part, without express written permission. Without limitation, this document does not
constitute an offer, an invitation to offer or a recommendation to enter into any transaction. The information contained in this document is based on material we believe to be reliable; however, we do not represent
that it is accurate, current, complete, or error free. Assumptions, estimates and opinions contained in this document constitute our judgment as of the date of the document and are subject to change without
notice. Any projections are based on a number of assumptions as to market conditions and there can be no guarantee that any projected results will be achieved. Past performance is not a guarantee of future
results. The services described in this document are provided by Deutsche Bank AG or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation. Deutsche Bank Securities
Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities in the United States. Deutsche Bank Securities Inc. is a member of NYSE, FINRA and SIPC. Investments are subject to
investment risk, including market fluctuations, regulatory change, counterparty risk, possible delays in repayment and loss of income and principal invested. The value of investment can fall as well as rise and you
might notget
back the
originally
invested at
any point in time. Copyright Deutsche Bank AG 2011.
Inflation
Hedging
it amount
& Trading
it Deutsche
Bank

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Deutsche Bank

Corporate and Investment Bank

Winning for our clients:

6.0 Inflation Options

5.0 Assessing Relative Value

InflationHedging it & Trading it

There has never been a better

Deutsche Bank is very strongly

The Deutsche Bank inflation

Inflation looks set to be volatile

We were recently voted the

Set out the challenges

InflationHedging it & Trading it

The Deutsche Bank Global

Deutsche Banks credentials and

InflationHedging it & Trading it

Deutsche Banks credentials and capabilities

Issuing long dated inflation in large

Lead syndication mandates awarded to market counterparties

*between September 2009 and February 2011

InflationHedging it & Trading it

We are outperforming the competition

Source: Bloomberg, Deutsche Bank

Source: Bloomberg, Deutsche Bank

Source: Bloomberg, Deutsche Bank

7,000 Total Syndication

InflationHedging it & Trading it

We are outperforming the competition

Source: Bloomberg, Deutsche Bank

Source: Bloomberg, Deutsche Bank

Source: Bloomberg, Deutsche Bank

Source: Bloomberg, Deutsche Bank

InflationHedging it & Trading it

How Deutsche Banks inflation offering differs

InflationHedging it & Trading it

InflationHedging it & Trading it

The rise and rise of inflation

InflationHedging it & Trading it

Industrial country sovereign linker

Components of Inflation Indices

Source: Deutsche Bank

Source: Deutsche Bank

Food and beverages

Food and catering

Source: Deutsche Bank

InflationHedging it & Trading it

Food & beverages

Inflation Linked Bonds

InflationHedging it & Trading it

Inflation Linked Bonds

Inflation Bonds Linkers

InflationHedging it & Trading it

A Canadian style Linker pays a real

Some ILBs (like US TIPS or OATei/i)

Real Yield and Breakeven Inflation and

Linkers save issuers the risk premium

The examples below assume an annual

Source: Deutsche Bank

Source: Deutsche Bank

Index Linked Bond

InflationHedging it & Trading it

Coupon Linker (2%)