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Total return swap: Definition from Answers.com

Wikipedia: Total return swap

Total return swap, or TRS (especially in Europe), or total rate of return swap, or TRORS, is a contract in which one party receives interest payments on a reference asset plus any capital gains and losses over the payment period, while the other receives a specified fixed or floating cash flow unrelated to the credit worthiness of the reference asset, especially where the payments are based on the same notional amount. The interest payments are floating payments and are usually based upon the LIBOR with a spread added according to the agreement between parties. The reference asset may be any asset, index, or basket of assets. TRORS are particularly popular on bank loans, which do not have a liquid repo market.

TRORS can be categorised as a type of credit derivative although it should be noted that the product combines both market risk and credit risk, and so is not a pure credit derivative.

The TRORS, then, allows one party to derive the economic benefit of owning an asset without putting that asset on its balance sheet, and allows the other (which does retain that asset on its balance sheet) to buy protection against loss in its value.

The essential difference between a TRORS and a credit default swap is that the latter provides protection not against loss in asset value but against specific credit events. In a sense, a TRORS isn’t a credit derivative at all, in the sense that a CDS is. A TRORS is funding-cost arbitrage.

Users

Hedge funds are using Total Return Swaps to obtain leverage on the Reference Assets: they can receive the return of the asset, typically from a bank (which has a funding cost advantage), without having to put out the cash to buy the Asset. They usually post a smaller amount of collateral upfront, thus obtaining leverage.

External links

See also

  • Repurchase agreement
Derivatives market
Derivative (finance)
Options
Swaps
Other derivatives

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