Filter by Categories
Accounting
Banking

Derivatives




Total Rate of Return Swap


A credit derivative (swap) in which the total return on a reference obligation such as a corporate bond (or an equity holding) is paid by the protection buyer (i.e., the total return payer), who owns the reference asset, to the protection seller (i.e., the total return receiver). In consideration, the protection buyer receives a riskless return (e.g., a floating rate plus a premium). If the reference obligation faces no default, the protection buyer passes on any return (interest, dividends, etc.) during the swap term to the protection seller.

Furthermore, the buyer pays the seller any price change on the reference asset over the life of the swap. But if the reference obligation would end up in default before maturity date, the seller bears the entire market risk and default risk associated with the reference asset. That means the seller pays the buyer the difference between the asset’s price at the start of the swap and its price at the time of default. For an illiquid reference asset, the seller may, instead of receiving cash settlement, take delivery of the asset from the buyer at the reference price set at the agreement date. As a result of either a cash or in-kind settlement, the swap exists no longer.

This swap is also called a total return swap.



ABC
Derivatives have increasingly become very important tools in finance over the last three decades. Many different types of derivatives are now traded actively on ...
Watch on Youtube
Remember to read our privacy policy before submission of your comments or any suggestions. Please keep comments relevant, respectful, and as much concise as possible. By commenting you are required to follow our community guidelines.

Comments


    Leave Your Comment

    Your email address will not be published.*