Also called a total rate of return swap, it is a derivative contract that replicates the cash flows of an investment in an asset (usually a debt or equity security, basket of securities, index or other financial instrument). In addition, a TRS also requires the parties to make payments to each other based on the performance of the underlying asset. Accordingly, one party, Party A, receives payment from the other, Party B, based on the appreciation in value of the asset(s) over a certain specified period (often monthly) or makes payments to Party B based on a decline in value of the asset during the specified period.

A TRS permits Party A to simulate investment in the underlying asset(s) without incurring the burden of ownership of the asset(s), including any adverse balance-sheet implications. The TRS simultaneously permits Party B to protect itself against a decline in value of the underlying asset(s).

The absence of a transfer of ownership in the underlying asset(s) allows greater flexibility and requires reduced up-front capital to execute a trade. This also means a party to a total return swap can be more highly leveraged.

TRS documents are usually based on International Swap and Derivatives Association (ISDA) standard documents.

For more on TRS, see Practice note, Equity derivatives: overview (UK): Total return swaps. For more on documenting swaps using ISDA documentation, see Practice note, ISDA documents: overview (UK).