Accrual and Mark-to-Market Valuation of Total Return Swaps
Summary
The document describes an accrual-style valuation of a total return swap with an index underlying. The asset leg reflects the index’s percentage change since the last reset, applied to an adjusted notional, while accrued coupon and financing amounts use the notional and elapsed time under day-count conventions. For a long position, the described calculation subtracts financing from the asset return. The question asks whether the coupon belongs in the asset leg and why the method does not project and discount future cash flows.
The replies characterize the approach as an older accrual method and say that mark-to-market valuation is now generally used, while some client-breakable trades may suspend forward-cash-flow treatment. One reply describes the coupon as the price paid for receiving the asset’s return. The discussion is brief and does not specify a complete contract or valuation framework, so its comments should not be treated as universal rules for every TRS.
Key ideas
- The described accrual method calculates asset return, coupon accrual, and financing from the period since the last reset.
- For a long position, the described valuation nets financing against the asset leg.
- The replies characterize accrual valuation as historical and mark-to-market as the more usual current approach.
- Client break rights may affect whether forward cash flows are included in valuation.
- The discussion does not establish a complete valuation method for every total return swap.
Tags
Full text
# Valuation of Total return swaps (TRS) # Valuation of Total return swaps (TRS) I have seen a TRS being valued which has an index as underlying on the asset side. It also has a coupon rate associated with it. Asset leg is calculated by taking ``` percentage change of asset value from last reset date to valuation date * adjusted notional ``` The interest accrued is calculated by multiplying ``` coupon rate * adjusted notional * ((val date-reset date)/360). ``` The financing leg is calculated by ``` index on last reset date/100 * LIBOR/100 * ((val date-reset date)/360) ``` Valuation of TRS is done by subtracting the financing leg from the asset leg if we are long. Will a coupon rate be always involved in the asset leg? And more importantly why is forward cash flows and discounting not done? Does this methodology of valuation pertain to only this type of TRS? ## Answer by jherek (score 3) https://quant.stackexchange.com/a/47484 I think this is the old accrual methodology, historically used for the banking book. I believe it is not market standard anymore and regulators require an MTM (mark-to-market) valuation. Here is an article that explains the difference between the two. And someone wrote a more mathematical paper, which should help you better understand the accrual valuation (although I don't find the notation great in that paper). ## Answer by JoshK (score 1) https://quant.stackexchange.com/a/47489 > Will a coupon rate be always involved in the asset leg? Absolutely. That's what makes it a TRS. The coupon is the price for the return of the asset. Without that coupon the TRS buyer would not receive any return and just be paying interest for no reason. > And more importantly why is forward cash flows and discounting not done? It usually is now! But many TRS trades are breakable by the client, so sometimes this functionality is suspended.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.