Bond Total Return Swap

ORE defines the product as follows:

A total return swap is a derivative contract in which one counterparty (short) pays out the total returns of an underlying asset and receives a regular fixed or floating cash flow from the other counterparty (long). Here we describe total return swaps with an underlying bond. The total return of the bond is comprised of

coupon, redemption and amortization payments of the bond, including recovery payments in case of default compensation payments that reflect changes of the clean bond value along the TRS schedule.

Source: ORE User Guide, Products catalogue, bondTotalReturnSwap.tex.

ORE describes the setup as follows:

A vanilla Bond Total Return Swap (Trade type: BondTRS) is set up using a BondTRSData block, which the catalogue shows in a listing. The block is split into three sub-blocks. ORE describes them as follows:

The block is comprised of three sub-blocks, which are BondData, TotalReturnData and FundingData.

Source: ORE User Guide, Products catalogue, bondTotalReturnSwap.tex.

A bond total return swap converts the return of a bond into a cash flow. One side pays the coupons and the price moves of the bond. The other side pays a funding rate on a notional. The bond owner keeps the bond but passes its economics to the other side.

The BondData block specifies the underlying bond, usually by SecurityId and BondNotional, relying on reference data. One bond always corresponds to a face value of one unit of bond currency. The SecurityId is typically the ISIN with the ISIN: prefix. Convertible bonds are not supported as underlyings for BondTRS; the TotalReturnSwap trade type should be used for them. The optional CreditRisk flag decides whether credit risk shows on the product. The TotalReturnData block specifies the return leg. Payer decides whether the total return leg is paid. InitialPrice is optional and holds a contractually given bond price for the first date of the total return schedule, in percent. PriceType decides whether the payments are based on dirty or clean prices. ObservationLag, ObservationConvention and ObservationCalendar derive the valuation dates from the ScheduleData reference schedule. PaymentLag, PaymentConvention and PaymentCalendar derive the payment dates, which can also be given explicitly in a PaymentDates node. FXTerms is mandatory when the bond currency differs from the return currency, which is always assumed to equal the funding leg currency. This kind of trade is also known as a composite TRS. FXIndex names the FX index for the conversion. ApplyFXIndexFixingDays decides whether the FX fixing date moves back by the usual number of fixing days. PayBondCashFlowsImmediately decides whether bond cash flows are paid when they occur, or together with the next return payment. The FundingData block specifies the funding leg, which can be of any leg type. It contains exactly one Leg, and its currency defines the currency in which the return is paid. The funding notional can follow the return leg through Indexings with FromAssetLeg set to true; the notionals node is not required in that case.

The total return leg pays the coupons, redemptions and amortisations of the bond plus the change in its clean value along the schedule. The funding leg pays a fixed or floating rate on the notional. The two legs net against each other on the payment dates. The return currency is the funding currency; a composite TRS converts the bond economics through an FX index when the currencies differ.

• The price of the underlying bond.
• The interest rates of the funding leg.
• The FX rate between the bond currency and the funding currency.
• The credit of the issuer, through the bond price and the recovery payments.

The swap passes the full economics of the bond to the receiver, so the bond price dominates the value. The funding leg offsets the carry.

The return leg marks to the bond on each date of the schedule. The receiver gets the coupons and the price moves as they happen, or at the next payment date. The funding leg accrues against it. At each payment date the difference between the two legs settles, and the trade resets for the next period.

A bond total return swap gives the return of a bond without funding the purchase. It suits a customer who wants bond exposure with leverage, or who must warehouse bonds off balance sheet. In ORE Studio a customer books bond total return swaps to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a composite bond TRS: a New Zealand bond pays its return in USD against a floating USD funding leg:

<BondTRSData>
  <BondData>
    <SecurityId>ISIN:NZIIBDT005C5</SecurityId>
    <BondNotional>100000</BondNotional>
  </BondData>
  <TotalReturnData>
    <Payer>false</Payer>
    <InitialPrice>102.0</InitialPrice>
    <PriceType>Clean</PriceType>
    <ObservationLag>0D</ObservationLag>
    <ObservationConvention>P</ObservationConvention>
    <ObservationCalendar>USD</ObservationCalendar>
    <PaymentLag>2D</PaymentLag>
    <PaymentConvention>F</PaymentConvention>
    <PaymentCalendar>TARGET</PaymentCalendar>
    <!-- <PaymentDates> -->
    <!--   <PaymentDate> ... </PaymentDate> -->
    <!--   <PaymentDate> ... </PaymentDate> -->
    <!-- </PaymentDates> -->
    <FXTerms>
      <FXIndex>FX-TR20H-NZD-USD</FXIndex>
    </FXTerms>
    <ScheduleData>
    ...
    </ScheduleData>
    <PayBondCashFlowsImmediately>false</PayBondCashFlowsImmediately>
  </TotalReturnData>
  <FundingData>
    <LegData>
      <Payer>true</Payer>
      <LegType>Floating</LegType>
      <Currency>USD</Currency>
      ...
      <!-- Notionals node is not required, set to 1 internally -->
      ...
      <Indexings>
      <!-- derive the indexing information (bond price, FX) from the total return leg -->
      <FromAssetLeg>true</FromAssetLeg>
      </Indexings>
      ...
    </LegData>
  </FundingData>
</BondTRSData>

Source: ORE User Guide, Products catalogue, bondTotalReturnSwap.tex, listing Bond Total Return Swap Data with indexed funding leg.