Total return swap
A swap in which one party receives the total return on a reference asset, income plus price change, and pays a fixed or floating rate. It gives the economic exposure without owning the asset.
Where you will meet it
Total return swap appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Explain how commodity swaps can be used to gain or adjust exposure to commodities
“In a total return swap the receiver gets the return on a commodity index and pays a floating rate such as the Treasury bill rate plus a spread, which suits a pension fund wanting passive exposure.”
- Contrast the vehicles through which an investor can gain index-based equity exposure
“Derivatives-based approaches use index futures, total return swaps or options: they are capital-efficient and quick to put in place, but futures must be rolled, carry basis risk and margin calls, and swaps add counterparty risk.”
- Set out the strategic choices in implementing an allocation, including how passive or active to be and which vehicles deliver each type of mandate
“Passive exposure can be delivered through index mutual funds, exchange-traded funds, separately managed index accounts, or derivatives such as futures and total return swaps, which also allow overlays.”
- Show how derivatives can set a portfolio's equity and interest rate exposures at chosen targets
“Swaps work too: a total return swap receiving the index adds equity exposure, and paying fixed cuts duration.”
Practise it
Practise total return swap until it is automatic: questions that explain every wrong option.
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