total return swaps

A type of credit derivative instrument. Swap contracts in which the protection buyer sells the total return from a particular reference asset such as a corporate loan or bond. In exchange, the protection buyer receives a rate of interest such as LIBOR.

Alternatively, the protection buyer may agree to receive the total return from a different reference asset. (In the first case, the protection buyer has reduced credit risk by taking a rate such as LIBOR and giving up the cash flow from a reference asset with credit risk. In the second case, the protection buyer is diversifying credit risk by exchanging the risk from one obligor for the risk for another obligor.)

Note that in a total return swap, the support seller is guaranteeing not just against default by the reference obligor but also against the deterioration in the credit quality of the reference obligor even if there is no default. " Total return" includes interest payments and changes in the market value of the reference asset. As a result, the total return of a credit asset can be affected by various factors, some of which may be quite extraneous to the asset in question, such as interest rate movements, exchange rate fluctuations etc.

Also known as a total rate of return swap or TROR swap. American Banker Glossary