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Is the value of a TRS just the difference between the "financing leg" (e.g. the side paying -IBOR plus spread) and "asset leg" (e.g. the side pay income and price changes), with of course the +/- of those values dependent on whether you're long or short?

Assuming yes, does the asset leg only consider income accrued up until, and appreciation up until, the mark to market / valuation date? Is there no consideration for the expected return of the asset somewhere? It seems odd that the value of the derivative is based only on what's happen so far, not what might happen next.

PS: to confirm TS like most swaps have zero value at inception. At maturity there is no exchange of notional.

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TRS are just financing trades. The dealer is charging you to place the asset on their balance sheet. So if you are receiving total return on stock A, you will receive appreciation and dividends over the swap term if any (or you will pay the dealer any depreciation less dividends, if any), and in turn pay the dealer interest on the initial value of Stock A at inception of the TRS.

One way of looking at this is the dealer will buy the stock on your behalf and give you the total returns of the stock (in fact the dealer will actually buy the stock as their hedge). Since the dealer has in effect loaned you the full amount of the stock purchase, they will charge you interest on this amount.

As you are now long the stock, the value of the position is just any appreciation or depreciation of the stock on value date. It is just like if you buy a stock, the profit or loss to you is the appreciation or depreciation of the stock--there is no future prospective gains or losses on the value of your stock position that is not embedded in the price of the stock. And on the financing leg, you are short any interest that you owe the dealer up to the valuation date. The net is the value of the swap.

As these are basically extensions of credit, there are periodic settlements of the total return and financing payments. On these days, the value of the swap again becomes zero, and the price of the stock on which to base future total return is reset to the current price.

Another way to look at these TRS is like a collateralized loan. It is similar to you buying the stock, posting it as collateral to the dealer for a loan of the purchase price. You then pay financing for the loan, and the dealer will pay you total return on the collateral they hold. If the value of the collateral goes up, you will receive the appreciation; if the value of the collateral goes down, you will have to post the difference so that the dealer holds the full value as collateral of the loan.

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  • $\begingroup$ Great answer, best description of TRSs that I have seen to date. $\endgroup$ Apr 12 at 15:04
  • $\begingroup$ Feels a little weird that the value "resets to zero" periodically, but your explanation makes sense. $\endgroup$
    – Five9
    Apr 14 at 0:31
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Yes. The value of the asset leg is just the value of the asset itself, because the TRS can be perfectly replicated by owning the asset. Alternatively, you could say that whatever the potential future performance of the asset, that information is contained in the current price of the asset.

The floating leg should ideally be valued by comparing the rate+spread to the current market rate for repoing the bond for the same remaining term as the TRS. This may be tricky in practice if there is insufficient market information, and some dealers may just make an estimate or assume the leg is worth par.

There are some variants of TRS where one counterparty has the right to unwind the TRS assuming the floating leg is terminated at its accrued value. In that case it may be more appropriate to value the floating leg at par, rather than looking at the current market price of repo.

Practices vary slightly among dealers about how the floating leg is treated, although the asset leg is always valued at the asset price, as far as I know.

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