What is a total return swap?

It’s an agreement between two parties whereby one pays the other based on a set interest rate in return for payments based on the return of an underlying asset. This asset is often a loan, bond or equity index. The idea is to transfer the credit risk from one party to another.

Where have you heard about total return swaps?

This type of arrangement is most commonly used by hedge funds as it's useful if a party wants to benefit from an asset without actually buying it. The two parties involved in a total return swap are known as the total return payer and receiver.

What you need to know about total return swaps.

The receiver gets any income from the asset, benefiting if the price rises over the swap's lifetime. For this, they have to pay the asset owner a set interest rate. If it's a floating rate, it's usually based on the current Libor rate .

A total return swap means a party can own an asset without having to list it on a balance sheet. The other party does have to list it, but has protection against any losses on the underlying asset.