Does sombody know exactly if a TRS is always breakable ? Or if breaking the TRS position is an option in the term-sheet. I need an accurate response.
Thank you !
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$\begingroup$ In practice, a client can get out of any TRS anytime. Don't recognize P&L with the assumption that a TRS won't be terminated. $\endgroup$– Dimitri VulisFeb 17, 2021 at 22:28
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1$\begingroup$ In my experience, when I used to trade equity TRS' with sizeable notional (eg on MSCI World), the term sheet does specify whether it is breakable or not. Reason being that if you hedge or offset the TRS to something else, especially for sizeable notionals, you don't want to be caught by surprise and have to unwind your hedge suddenly, especially not in a volatile market. Hence there can be a break-fee. Maybe things have changed though. $\endgroup$– user34971Feb 18, 2021 at 7:21
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3 Answers
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A TRS is an OTC trade so the terms are negotiable. Some TRS's are breakable and some are not. Some TRS trades are locked in with multi-year terms and some are daily breakable. It really depends on what the counterparties want to do.
As a general rule you will find that dealer-to-dealer trades are locked and customer-to-dealer trades are fully breakable. But that's not always the case.
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TRS are OTC. You can set any terms that both parties accept. That includes rate, tenor, break rights. Etc etc etc
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$\begingroup$ Agreed. Confirm should state any contractual break rights , if they exist. Otherwise , transaction can be unwound at dealer unwind price. $\endgroup$– dm63Mar 21, 2021 at 4:32
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The reason that break rights are important is because they influence how the trade can be hedged.
Let's say, for example, that i sell you a swap on $100m of apple, expiring in a year. I have a few ways i can choose to hedge this -
- I can buy \$100m of apple shares and hold them to expiry
- I can buy \$100m of apple futures to some date near to the expiry of the swap
- I can ask my brokers if anyone wants to trade a forward on apple with me, otc.
We'll ignore option 3, as it's basically just passing the risk off to someone else, and doesn't really provide any insight here. For option 1, we can to consider that it's going to cost me \$100m to buy all those shares, which means i need to borrow $100m from somewhere to do so (where that cost of funding the position will get included in the swap fee i charge you). In option 2, i don't need to fund the futures position, i only need to pay margin, let's say 20%, so i need to borrow less money, which means lower costs - so i can show you a much cheaper swap fee (i.e. i can be more competitive with otherse you ask for a swap rate).
If we now add in a clause where the swap is breakable at any time, and if it's broken, then the payout is current price - strike price (instead of forward price - strike price), then if i hedge using futures and the spot/futures basis moves against me, then i can potentially lose money on the unwind - i.e. it is not a good hedge. Because of this, the correct way to hehdge the breakable variant is to buy the actual stocks, so the breakable swap should have a higher cost, since the funding costs are higher.
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$\begingroup$ Thank you Will for this explanation. It is very beneficial. The question was on the difference between breakable Equity swaps and collable swaps. I don't know what is the difference between both $\endgroup$– OuissemJun 18, 2021 at 11:43
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$\begingroup$ Callable normally means that someone has the option to call the trade early. Who has the rights to call it, and what economic impact it has will determine the specifics. Some examples are Autocallables (notes which automatically call if certain events happen), Issuer callables (notes where the issuer has the option to call), and some notes give the holder the option to call. When the call right is exercised, the trade will end and typically some amount is paid (where the amount is set out in the terms). Breakable is similar, and depends on the terms. Do you have specific examples? $\endgroup$– willJun 19, 2021 at 12:56
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$\begingroup$ Thank you Will and sorry for the delay. I'm not often in the site. I don't have example, but I've seen the field in the booking templates of TRS instrument. I think that the breakability could be exercised at any time if confirmed in the term-sheet while the collability is linked to some events and results in some fees. $\endgroup$– OuissemSep 29, 2022 at 11:54