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I have seen a TRS being valued which has an index as underlying on the asset side. It also has a coupon rate associated with it. Asset leg is calculated by taking

percentage change of asset value from last reset date to valuation date * adjusted notional

The interest accrued is calculated by multiplying

coupon rate * adjusted notional * ((val date-reset date)/360).

The financing leg is calculated by

index on last reset date/100 * LIBOR/100 * ((val date-reset date)/360)

Valuation of TRS is done by subtracting the financing leg from the asset leg if we are long.

Will a coupon rate be always involved in the asset leg? And more importantly why is forward cash flows and discounting not done? Does this methodology of valuation pertain to only this type of TRS?

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    $\begingroup$ A more mathematical description would help tremendously readers to understand what you refer to with the terms "involved", "not done", and which kind of TRS. Mark-to-market valuation of a TRS is done using discounting of forward flows. $\endgroup$ – jherek Sep 4 at 8:30
  • $\begingroup$ edited the question and added more details $\endgroup$ – Rejath Johny Sep 4 at 10:08
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I think this is the old accrual methodology, historically used for the banking book. I believe it is not market standard anymore and regulators require an MTM (mark-to-market) valuation.

Here is an article that explains the difference between the two. And someone wrote a more mathematical paper, which should help you better understand the accrual valuation (although I don't find the notation great in that paper).

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  • $\begingroup$ can you be more specific about the procedure I have described? I need to know more about it $\endgroup$ – Rejath Johny Sep 4 at 11:59
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    $\begingroup$ That still works for an open TRS (breakable at any time by both parties), breakability is what determines whether to price MTM or accruals $\endgroup$ – Lliane Sep 5 at 1:05
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Will a coupon rate be always involved in the asset leg?

Absolutely. That's what makes it a TRS. The coupon is the price for the return of the asset. Without that coupon the TRS buyer would not receive any return and just be paying interest for no reason.

And more importantly why is forward cash flows and discounting not done? It usually is now! But many TRS trades are breakable by the client, so sometimes this functionality is suspended.

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  • $\begingroup$ "Without that coupon the TRS buyer would not receive any return". I am not sure I understood, without the coupon the buyer would still receive/pay the price changes ("price return") on the index, am I rite? $\endgroup$ – Alex C Sep 4 at 16:31
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    $\begingroup$ Sorry, to be more explicit. The TRS buyer pays interest (usually one of [1m libor, 3m libor, OIS] ) + a spread of some sort . He receives the return of the asset. Without this interest component it's not really a TRS. The definition of a TRS is basically "I pay you interest - you pay me performance". If you vary from that definition it's not really called a TRS. At least not anything that I've traded/seen. $\endgroup$ – JoshK Sep 4 at 17:57
  • $\begingroup$ My question is, it can be seen that we calculate the percentage return of the index on the asset leg. Then in top of that why is there a coupon again on asset leg. Returns is taken care of when we take the difference in index at valuation and reset dates right? $\endgroup$ – Rejath Johny Sep 5 at 2:38
  • $\begingroup$ I think you have some confusion in your terminology. It's not a financing leg and an interest leg. They are one and the same thing. You have an interest leg, which accrues the financing and the performance leg, which pays the performance. TRS = "Total Return Swap", so in the performance leg you get any coupon or dividend (subject to tax rules). If you didn't pass on coupon/div it would be a "price return swap", which really doesn't trade. $\endgroup$ – JoshK Sep 5 at 13:46

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