Chapter 48. The Valuation of Fixed Income Total Return Swaps


Associate Professor of Finance, Rutgers University


Professor in the Practice of Finance, Yale School of Management

Abstract: 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). The reference asset could be a credit-risky bond, a loan, a reference portfolio consisting of bonds or loans, an index representing a sector of the bond market, or an equity index. A total return swap can be used by asset managers for leveraging purposes and/or a transactionally efficient means for implementing a portfolio strategy. Bank managers use a total return swap as an efficient vehicle for transferring credit risk and as a means for reducing credit risk exposures. The Duffie-Singleton model can be used to value total return swaps.

Keywords: total return swap, Duffie-Singleton model, forward measure

In this chapter we explain the valuation of total return swaps. We begin with an intuitive approach. Total return swaps and their applications are discussed in Chapter 43 of Volume I.


A typical total return swap is to swap the return on a reference asset for a risk-free return, usually the London Interbank Offered Rate (LIBOR). The cash flows for the swap buyer (that is, the total return receiver) are shown in Figure 48.1. In the figure, Lt is ...

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