A total rate of return swap (TRORS), sometimes called a Total Return Swap or TRS, is a financial contract that transfers both the credit risk and market risk of an underlying asset. One party makes payments based on a set rate (either fixed or variable) and the other party makes payments based on the return of the underlying asset (which includes income it generates and any capital gains). The underlying asset is usually a bond or loans or an equity index. TRORSs allow the party receiving the total return (the TRORS recipient or investor) to gain exposure and benefit from a reference asset without actually having to own it.
The key reason receivers of the total rate of return enter into this transaction is to take advantage of leverage. […] The payer in a TRS creates a hedge for both price risk and default risk of the reference asset, although the payer in the TRS is a legal owner of the reference asset. Investors who cannot short securities may be able to hedge a long position by paying the total rate of return in a TRS.
See Janet Tavakoli, Introduction to Total Return Swaps (available at http://www.tavakolistructuredfinance.com/trs/) for a good overview of TRORSs. See this video for a basic overview of Total Rate of Return Swaps.
TRORSs can be combined with tender option bond programs. For notes concerning tender option bond programs, see this posting.
See PLR 201502008 (May 21, 2014): Extension of the TRS is not an abusive arbitrage device and the TRS will not be integrated with the bonds under the authority of 1.148-10(e). The issuer/borrower agree to file a “cautionary” IRS Form 8038 just in case the IRS might mistake the bonds for having been reissued.
See “IRS Issues Favorable But Limited Ruling on Total Return Swaps” article in the January 27, 2015 edition of The Bond Buyer.