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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Sign up to join this communityDoes 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 !
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.
TRS are OTC. You can set any terms that both parties accept. That includes rate, tenor, break rights. Etc etc etc
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 -
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.