Handbook of Finance: Financial Markets and Instruments

Chapter 43. Fixed Income Total Return Swaps

MARK J. P. ANSON, PhD, JD, CPA, CFA, CAIA

President and Executive Director of Nuveen Investment Services

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

MOORAD CHOUDHRY, PhD

Head of Treasury, KBC Financial Products, London

REN-RAW CHEN, PhD

Associate Professor of Finance, Rutgers University

Abstract: The total return on a bond, bond portfolio, or bond index is taken into account interest income and any capital gain or loss realized. In the fixed income market, derivative instruments that allow an investor to obtain exposure to the total return of a bond, bond portfolio, or bond index without the actual purchase of the underlying is available. This derivative instrument is a total return swap. Similarly, a total return swap can be used to short the underlying without the need to borrow it.

Keywords: total return swap, total return bond index swap, total return index swap, swap buyer, swap seller, interest rate swap, basis swap, funding leg, synthetic repo

A total return swap is a swap in which one party makes periodic floating rate payments to a counterparty in exchange for the total return realized on a reference asset (or underlying asset). In the fixed income market, reference asset could be a credit-risky bond, a reference portfolio consisting of bonds or loans, or an index representing a sector of the bond market. We first explain how a total return swap can be used when the reference asset is ...