There is no doubt that credit risk management is of utmost importance to the banking industry. With the rise in competition, banks have to undertake increasingly riskier deals at lower margins. One possible way of transferring the credit and interest rate risk faced by banks is through Total Rate of Return swaps or Total Return Swaps (TRS).

TRS can be defined as a contract between two counterparties, whereby they exchange the total return of an asset between them in order to transfer the credit risk from one counterparty to the other. It is one of the most suitable credit derivatives for banks that want to manage their credit exposure. Usually, the return of a bank loan or any other credit-based asset is exchanged for some other cash flow that can be tied to a floating rate or even for another credit sensitive security.

There is no need to match the maturity of the underlying assets. TRS differs from credit default swaps in the sense that there is no need to wait for the occurrence of a credit event like a default. Here, the interest rate risk is also transferred as the counterparty will receive the total cash flows of a bond, without actually owning the bond.

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