Total Return Swaps

A TRS is a swap agreement in which a party pays fixed or floating interest and receives the total return of an asset. The total return is defined as the capital gain /loss from the asset in addition to any interest/dividends received during the life of the swap. The party that pays fixed/floating rates believes the asset will appreciate. A total return swap enables both parties to gain exposure to a specific asset without having to pay additional costs for holding it. 

 

An equity swap is a particular type of total return swap where the asset can be an individual stock, a stock index or a basket of stocks. Compared to holding the stock, she does not have to pay anything up front. Instead, she would deposit an amount of money, equal to the spot price of the stock (a different amount in the case of a margin), and would receive interest on it. 

 

Thus, the investor creates a synthetic equity fund by making a deposit and being long the equity swap. Typically, equity swaps are entered into to gain exposure to an equity without paying additional transaction costs, locally based dividend taxes. It also enables investors to avoid limitations on leverage and to get around the restrictions concerning the types of investment an institution can hold. 

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