The question remains whether the increase in spreads, which hedge funds are willing to pay as refinancing fees, are sufficient to compensate banks for credit risk. I have attended presentations where these are the only reasons for the motivation of the recipient of the overall return. The above reasons are often true. But it`s like saying that the reason you drive a Porsche Targa on a track is because it drives you faster than on foot. While this is true, this is not the point of what you are doing. The main reason why the recipients of the total return enter into this transaction is the use of leverage. Investors do not make an initial payment in cash. Cash flows are generally paid net. The investor`s “payments” are deducted in advance from the cash flows of the securities. The investor does nothing but receive a positive net payment. (This assumes that the investor`s funding costs remain below the cash flows generated by the security. If the investor receives a fixed coupon and makes a variable payment, the investor may be able to pay net in an inverted curve environment.) Leverage is why hedge funds are a primary target as counterparties in TRS. Hedge funds are the beneficiary of the overall return.

The main motive for hedge funds is to take advantage of leverage. The participation of hedge funds and other fragile loans, although partially guaranteed, is a critical development and not necessarily welcome in the credit derivatives market. While the reason for the counterparty of hedge funds is leverage, the reason for paying the overall return in the TRS is to report high profits. We`ll take a closer look at this transaction and the quality of those profits in the section on hedge funds. As a general rule, no prior guarantee is required for a solvent bank or other solvent beneficiary. The recipient does not put cash. The earned spread is pure spread income; interest earned on the TRS, net of the recipient`s financing costs. A return total swap looks like a bullet swap; However, in the case of a Bullet swap, the payment is deferred until the end of the swap or the closing of the position. Total Return Swap or TRS (especially in Europe) or Total Rate of Return Swap or TRORS or Cash Settled Equity Swap is a financial contract that transfers both credit risk and market risk from an underlying.

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