Total Return Swap

A total return swap (TRS) is a financial derivative contract in which two parties agree to exchange the cash flows of two different underlying assets. The most common underlying assets are bonds, stocks, or commodities. The party that agrees to pay the total return of the underlying asset is known as the "payer" and the party that agrees to receive the total return is known as the "receiver."

The total return of an asset is the sum of its income and capital appreciation. The income from an asset can come from dividends, interest, or rent. The capital appreciation of an asset is the difference between its purchase price and its sale price.

In a TRS, the payer typically receives a fixed payment from the receiver. In exchange, the payer agrees to pay the receiver the total return of the underlying asset. The fixed payment can be based on a benchmark interest rate, such as LIBOR or the U.S. Treasury yield curve.

The receiver in a TRS typically has a long position in the underlying asset. This means that the receiver expects the underlying asset to appreciate in value. The payer in a TRS typically has a short position in the underlying asset. This means that the payer expects the underlying asset to depreciate in value.

TRSs are often used to hedge against interest rate risk, currency risk, or commodity price risk. For example, a company that owns a bond portfolio may use a TRS to hedge against interest rate risk. The company would enter into a TRS with a bank, where the company would agree to pay the bank a fixed interest rate and the bank would agree to pay the company the total return of the bond portfolio. If interest rates rise, the company would lose money on its bond portfolio but would make money on the TRS. If interest rates fall, the company would make money on its bond portfolio but would lose money on the TRS.

TRSs can also be used to speculate on the future value of an underlying asset. For example, a trader who believes that the price of oil will rise may enter into a TRS with a bank, where the trader would agree to pay the bank a fixed price for oil and the bank would agree to pay the trader the total return of the oil price. If the price of oil rises, the trader would make money on the TRS. If the price of oil falls, the trader would lose money on the TRS.

TRSs are complex financial instruments and should only be used by experienced investors.