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Inflation has become one of the most central economic topics in recent years, especially following the COVID19 pandemic and the war in Ukraine. Large changes in inflation have affected households, firms and financial markets, while also increasing the need for protection against inflation risk. One common tool for this purpose is inflation-linked securities, such as Treasury Inflation-Protected Securities, where cash flows are linked to a consumer price index.

The purpose of this thesis is to provide an overview of inflation, explain how inflation-linked securities function, and examine how inflation affects the valuation of such instruments. The practical part of the thesis focuses on constructing a simplified pricing model for a U.S. inflation-linked bond in order to illustrate the relationship between inflation, discounting and valuation.

The results show that it is difficult to obtain realistic estimates of market inflation expectations using a simplified model and limited publicly available data. Under the assumptions used in the simulation, the model produces a slightly negative breakeven inflation rate. The result is highly sensitive to the assumed nominal discount rate, as demonstrated in the sensitivity analysis, where higher discount rates produce breakeven inflation estimates closer to zero or positive values.

The conclusion is that the model functions primarily as an illustration for demonstrating how inflationlinked securities are valued and how inflation assumptions affect cash flows and present value. To obtain more market-realistic results, additional inputs such as nominal and real yield curves would be required.