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Total Return Swap

A Total Return Swap (TRS) is a financial contract in which one party agrees to pay the total return of a specific asset or index (including capital gains, dividends, and interest) to another party in exchange for a fixed or floating payment. TRSs are commonly used to transfer the economic exposure of an asset without actually owning it. This allows one party to benefit from the asset’s performance while the other party hedges or reduces its exposure to the underlying asset.

Example

An investor enters into a TRS with a bank, where the investor receives the total return of a stock index, while the bank receives regular fixed payments from the investor, regardless of the index’s performance.

Key points

• A financial contract where one party pays the total return of an asset to another party in exchange for fixed or floating payments.

• Allows exposure to an asset without direct ownership.

• Commonly used for hedging or speculative purposes.

Quick Answers to Curious Questions

It enables investors to receive the returns of an asset without having to own it, while the counterparty takes on the ownership risk.

Counterparty risk and market risk are key concerns, as the party receiving the asset’s return depends on the counterparty’s solvency and market conditions.

TRSs allow institutions to hedge against specific asset exposures while receiving regular payments, without having to sell or buy the underlying assets.