Definition of a Total Return Swap (TRS), or Total Rate of Return Swap, (TRORS): A total return swap is considered a type of credit derivative, and it is fundamentally a form of financing. An “investor” uses financing, i.e., leverage, and obtains the economic benefits of an asset (or assets) without owning the asset or ballooning its balance sheet. The investor’s counterparty essentially finances the asset/s for the investor and buys protection against both credit/value deterioration and loss. The investor is the receiver of the total return on a reference asset/s including interest capital gains/losses or other economic benefits during the pre-defined payment period. The investor's counterparty receives a specified fixed or floating cash flow usually related to the credit worthiness of the investor. Typical reference assets include bonds, loans, indexes, hedge fund obligations, equity and commodities. The reference asset may be virtually any financial obligation.

Total return swaps are popular with hedge funds due to the leverage they provide. Banks and investment banks with lower funding costs usually require upfront collateral from hedge funds that is a fraction of the initial asset value, often allowing hedge funds 20:1 leverage.

Adapted and simplified from:
Tavakoli, J. Credit Derivatives & Synthetic Structures, John Wiley & Sons, 2nd Edition 2001 (First Edition 1998).