Total Return Swap (TRS)
A derivative in which one party receives all cash flows from a reference asset and pays a floating interest rate in return.
What is Total Return Swap?
A total return swap (TRS) is an over-the-counter derivative contract in which the total return receiver receives all cash flows generated by a reference asset — including coupon or dividend payments and capital appreciation — while paying a floating rate (typically SOFR or a related rate plus a spread) to the total return payer. The total return payer retains legal ownership of the reference asset but transfers all economic exposure. TRS instruments allow the receiver to gain leveraged economic exposure to an asset without purchasing it outright, and allow the payer to hedge economic risk while retaining balance sheet ownership. They are widely used by banks hedging loan portfolios, hedge funds seeking leveraged credit exposure, and in the structuring of synthetic CDOs.
Example
A hedge fund enters a total return swap on a $100 million corporate bond portfolio with a bank. The fund pays SOFR + 80 bps quarterly to the bank and receives all coupon payments plus any price appreciation of the bond portfolio. If the portfolio gains 5% ($5M) and coupons total 4% ($4M) over the year, the fund collects $9M gross, minus the floating payments. The fund gains full economic exposure to $100M of bonds with no outright purchase required.