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What is the total return swap (TRS)?
Total return swap (TRS) is an agreement between the two parties in which they exchange returns on financial assets. One party will pay on a set rate and the other will pay on the total return of the underlying asset (bond, loan, equity interest etc.). In this swap, the party receives an income without owning it.
The characteristics of total return swap are as follows −
- Referenced asset.
- It clearly states what is included in the total return.
- Reference index.
- Spread included.
- Whether notional is fixed or not
- Receive or pay.
- Swap price.
- Effective date and maturity date.
- Payment frequency.
The two types of TRS are as follows −
Credit derivative − Referred underlying asset is debt.
Equity derivative − Referred underlying asset is equity.
The advantages of TRS are as follows −
- Used for funding.
- Exposure to restricted markets.
- Notional amount is referred to by paying total sum.
- Not necessary to hold underlying assets.
- Credit risk (default counterparty, asset issuer could be default).
- Market risk (interest rate, equity and currency risk).
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