Total return swap

A total ( rate of) return swap ( TRORS or TRS) is a credit derivative in which the income and price fluctuations of the underlying financial instrument (the underlying or reference asset ) are exchanged for fixed or scheduled interest payments.

Operation

With a TRS one party, the protection buyer (also: protection buyer ) transfers the entire risk of the underlying asset (typically a bond) to the second contracting party, the protection seller ( Protection Seller ). To achieve this, the yields from the underlying (eg coupon payments ) and its increase in value against the payment of a normal point floating rate (eg EURIBOR) and the balance of the impairment with the collateral provider periodically compensated (see figure). Thus, the guarantor takes over by the secured party for the term of the transaction in addition to the credit risk and the overall market price risk from the reference. Thus, the TRS is essentially a combination of a credit default swap and normal interest rate swap.

Due to the total return swap, both parties bear the risk of loss. Tells the underlying price increases on, the protection buyer has to pay this the guarantor. Conversely suffered by the guarantor losses from the TRS, if the underlying has losses.

Background

Total return swaps for some years, for example, used by insurers or pension funds that have adopted fixed interest rate guarantees to their customers. With total return swaps they secure for volatile investments if they are to be kept permanently, if possible, at times the required interest from. On the other hand, can be built with a TRS synthetically gain exposure to the underlying asset. When compared to direct investment, ie the purchase of the underlying asset, the investment via TRS is liquidity friendly. This can be for the investor lower funding costs, which are represented in the TRS on the payment of variable interest rates mean.