Total Return Swap (Asset versus Funding Leg)

kiann · January 28th, 2014, 12:57 pm

Hi all, I am trying to set up the pricing of a total return swap with a specified funding leg, and a discounting leg (for CSA purposes).The papers I've read state the pricing of a TRS is straightforward for a non-dividend stock or asset. The forwards of the asset should grow merely at the funding leg (let's assume Libor).Why wouldn't the volatility of the stock or asset by taken into account?Thanks!

daveangel · January 28th, 2014, 1:02 pm

there is no convexity in the trs... the notional is reset at regular periods so the net payment reflects any growth or loss in the asset. I guess you will need to margin it somehow and thats where volatility comes in.

kiann · January 28th, 2014, 1:47 pm

Thanks DaveAngel.A slight discourse, if I assume 1) both the funding leg and the discount curve to be the same2) the reference asset to grow at the funding legWouldn't it mean the TRS is merely the equivalent of an interest rate swap of the specified tenor?

daveangel · January 28th, 2014, 2:28 pm

not really - a fixed rate in an IRS is an "average" of the expected libor over the term of the swap for a fixed notional. in a trs the notional is reset so essentially each sub-period is a borrowing against the asset.