Total rate of return swap
A total (rate of) return swap ( TRORS or TRS ) is a credit derivative in which the income and fluctuations in value of the underlying financial instrument ( underlying or reference asset ) are exchanged for fixed interest payments.
functionality
With a TRS a contractor, the transferred protection buyer (also: Protection Buyer ) the total risk of the underlying (typically a bond ) to the second contracting party, the guarantor ( protection seller ). In order to achieve this, the income from the underlying (e.g. coupon payments ) as well as its increase in value are periodically offset against the payment of a normally variable interest rate (e.g. EURIBOR ) and the compensation of the depreciation with the protection seller (see figure) . Thus, the protection seller assumes not only the credit risk but also the entire market price risk from the reference asset from the protection buyer for the term of the transaction . The TRS is thus essentially a combination of a credit default swap and a normal interest rate swap .
Both contracting parties bear the risk of loss through the total return swap. If the base value shows price increases, the protection buyer has to pay these to the protection seller. Conversely, the protection seller suffers losses from the TRS if the underlying exhibits price losses.
backgrounds
Total return swaps have been used for a number of years. B. used by insurers or pension funds that have given their customers fixed interest guarantees. With total return swaps, you temporarily hedge the required interest rate for volatile investments, if these are to be held permanently if possible. On the other hand, a TRS can synthetically build up exposure to the underlying asset. Compared to a direct investment, i.e. buying the underlying asset, investing via TRS is more liquidity-friendly . This can mean lower refinancing costs for the investor , which in the case of the TRS are represented by the payment of variable interest.
See also
literature
- Gunter Dufey, Florian Rehm: An introduction to credit derivatives. University of Michigan, Business School, Faculty Research 2000, p. 4 ( PDF ).