Equity Swaps and Total Return Swaps

An equity swap is a trade in which two parties exchange the return on a stock or a stock index for interest at a floating rate plus a spread over an agreed period. A total return swap (TRS) is a trade that exchanges the total return on a reference asset, meaning its price appreciation or depreciation plus income such as dividends or interest, and a TRS on a stock is a type of equity swap.

This trade comes up when a hedge fund wants a stock's price moves without buying the stock, and when a dealer takes the fund's order and hedges it with the underlying shares.

Exchanging an equity return for interest

An equity swap is a swap that exchanges payments linked to the price moves of a stock index or similar for payments linked to an interest rate. For example, one party pays a floating rate plus a spread and receives the return on a stock index. The notional amount, on which the payments are calculated, is usually a fixed amount that does not change during the term¹. The general form of swaps is covered in How Swaps Work.

A total return swap (TRS) is a trade that exchanges the total return on a reference asset: its price appreciation or depreciation plus income such as dividends or interest. The seller of a TRS pays the price appreciation and the income, and the buyer pays the price depreciation and interest based on a floating rate. A TRS on a stock is also called an equity swap. Reference assets include bonds, loans and stock indexes as well as stocks². A TRS on a bond or a loan is also used to transfer credit risk (as a credit derivative)³.

Below, the party receiving the equity return is the buyer of a TRS, and the party paying it is the seller. Consider a hypothetical example in which Fund V enters into the following TRS with Bank W on the shares of a listed company.

Term	In this example
Party receiving the equity return	Fund V
Party paying the equity return	Bank W
Number of shares	1 million shares
Share price at the start	10,000 yen per share
Notional amount	10 billion yen (1 million shares × 10,000 yen)
Term	6 months (2 payments, every 3 months)
Interest Fund V pays	3-month floating rate + spread of 0.50% a year
Resetting the notional amount (reset)	None

No principal changes hands when the trade is made. Without paying 10 billion yen to buy the shares, Fund V gets, through the payments, the same price moves as if it held 1 million shares.

Calculating the payments for each period

The payments are calculated separately for the equity side and the interest side. On the equity side, the share price is fixed at the end of each period. If the price has risen, Bank W pays the rise, and if it has fallen, Fund V pays the fall³. When the company pays a dividend, Bank W pays Fund V an amount equal to the dividend². Let $N$ be the number of shares, $S_0$ and $S_1$ the share prices at the start and end of the period, and $D$ the dividend per share paid during the period. The equity side, seen from Fund V, is as follows.

\text{Equity side} = N \times (S_1 - S_0) + N \times D

If the value is positive, Fund V receives it; if it is negative, Fund V pays it. On the interest side, Fund V pays the notional amount $A$ times the sum of the floating rate $r$ and the spread $s$ , times the length of the period $\tau$ in years.

\text{Interest side} = A \times (r + s) \times \tau

In the example trade, suppose the floating rate is 1.00% a year in both periods. The interest side is then 10 billion yen × (1.00% + 0.50%) × 0.25 = 37.5 million yen in each period⁴. Suppose also that the share price rises to 10,500 yen in period 1, returns to 10,000 yen in period 2, and a dividend of 100 yen per share is paid in period 2. Fund V's payments are then as follows⁵.

Fund V's payments	Period 1 (10,000 yen → 10,500 yen)	Period 2 (10,500 yen → 10,000 yen, dividend of 100 yen)
Change in the share price	+500 million yen	−500 million yen
Dividend	0	+100 million yen
Interest	−37.5 million yen	−37.5 million yen
Net	+462.5 million yen	−437.5 million yen

In period 1, when the share price rose, Fund V receives a net 462.5 million yen. In period 2, when it fell, Fund V pays a net 437.5 million yen. Bank W's payments are always in the opposite direction to Fund V's.

Figure 1Payments on the TRS seen by Fund V

Figure description

Payments of Fund V, which receives the equity return, on a TRS with a notional amount of 10 billion yen and a term of 6 months. Nothing changes hands at the start of the trade. After 3 months, the share price has risen from 10,000 yen to 10,500 yen, so Fund V receives the price rise of 500 million yen from Bank W and pays Bank W interest of 37.5 million yen. After 6 months, the share price has fallen from 10,500 yen to 10,000 yen. Fund V pays Bank W the price fall of 500 million yen. It receives 100 million yen from Bank W in place of the dividend paid during the period, and pays Bank W interest of 37.5 million yen. The length of each arrow is a rough guide to the size of the amount. Bank W's payments are in the opposite direction to Fund V's at every point.

The notional amount is set by multiplying the number of shares by the share price at the start. In a published confirmation from 2007, the number of shares is the number the dealer actually managed to buy as a hedge, and the share price at the start is the average price of those purchases⁶. Whether the notional amount is reset during the term is also agreed for each trade. In the same example, the reset does not apply. Dividends are paid as the amount a holder of the shares would have received, less taxes⁷. The example trade has no reset, so the interest for period 2 is also calculated on 10 billion yen.

For systems professionalsTerms listed in a confirmation

A system that holds the terms of a trade keeps items for the equity side and the interest side separately. In the published 2007 confirmation, the terms are set out under items such as the following⁶⁷⁸. The equity side lists the underlying shares and exchange, the number of shares, the share price at the start, the notional amount, whether there is a reset, and the type of return (Total Return). The dividend period, the way the dividend amount is set, and the dividend payment dates also belong to the equity side. For the interest side, they are the reference rate and its tenor, the spread, the day count convention, the payment dates, and the dates on which the rate is reset. The final share price is the average of the volume-weighted average prices on several set days.

How it differs from buying the stock with borrowed money

Fund V's gains and losses are close to what it would get if it borrowed 10 billion yen at a floating rate plus a spread and bought and held 1 million shares. The differences are that Fund V does not become a shareholder, and that the amount paid in place of dividends is set by the terms of the trade (in the 2007 confirmation, the amount less taxes⁷). Over the two periods of the example, the share price returned to 10,000 yen, so the gain or loss from price moves is zero. Fund V receives the dividend of 100 million yen and pays interest of 75 million yen, for a net receipt of 25 million yen. If Fund V had bought and held the shares with borrowed money, the gain or loss from price moves would also be zero at the same share price. It would receive dividends of 100 million yen, and if the interest on the borrowing were the same 75 million yen, the net result would be the same 25 million yen.

The payments on the interest side of a TRS amount to lending and borrowing money. The interest rate reflects the cost to the party paying the equity return (usually a dealer) of funding the position or its hedge⁹. The spread depends on the creditworthiness of the party paying the interest, the reference asset, the dealer's funding costs, its profit, and the capital required for the TRS, among other factors¹⁰. For Fund V, then, the TRS works much like borrowing money from Bank W to buy the shares.

If the share price falls sharply, Fund V's losses become large, just as they would if it held the stock. Under the terms of the example, if the price fell from 10,000 yen to 8,000 yen in one period, Fund V would pay the price fall of 2 billion yen plus interest of 37.5 million yen. Entering into a TRS with a large notional amount while holding little cash applies leverage, as buying stock with borrowed money does, so gains and losses swing widely relative to the cash on hand.

What equity swaps are used for

Some hedge funds use equity swaps to bet on the direction of the stock market¹¹. In this use, as in Fund V's example, the fund gets the price moves without buying the stock⁹. Conversely, when the holder of an asset takes the side paying the total return, it can pass the asset's price moves to the other party while keeping the asset (for example, a bank holding loans may use a TRS to reduce its credit risk³).

Swaps that receive the return on a stock index are also used on top of a bond portfolio to create the same effect as investing in stocks. For example, suppose a portfolio manager holds assets yielding a floating rate plus 0.20% and enters into a swap. If it pays the floating rate and receives the return on a stock index, the manager's return becomes the return on the index plus 0.20%¹². If the index falls, the manager pays the fall and makes a loss.

Dealers' hedges and holding of the stock

A dealer that takes the side paying the equity return usually buys the underlying stock as a hedge. According to the complaint in a lawsuit the SEC filed in 2022, the financial institutions on the other side of the TRS, consistent with industry standards, fully hedged the positions created by the trades and bought the underlying shares in the market to do so. These trades were handled by units such as those called Delta One desks¹³.

Suppose Bank W hedges by buying 1 million shares at 10,000 yen each, 10 billion yen in total, when the trade is made. In period 1, the shares it holds rise in value by 500 million yen, and it pays Fund V 500 million yen. In period 2, the shares fall in value by 500 million yen, and it receives 500 million yen from Fund V. For the dividend, it pays Fund V the 100 million yen it receives as a shareholder. However the share price moves, Bank W's gains and losses on the shares and its payments on the TRS offset each other, leaving Bank W with the interest it receives from Fund V. Bank W uses this interest to cover the cost of funding 10 billion yen of shares⁹.

Because the dealer holds the shares, the owner of the shares and the party that bears the gains and losses from price moves are different. The dealer appears as the shareholder, while the party receiving the equity return does not hold the shares¹⁴. This leads to the difficulty of seeing positions, covered in the section "Why large positions are hard to see."

Counterparty risk and margin

A TRS is a bilateral OTC derivative that is not traded through an exchange, and each party bears the risk that the other fails to pay as agreed. A report the SEC published in June 2026 tallies the equity security-based swaps reported to DDR, one of the US security-based swap data repositories. A "security-based swap" is a category under US rules for swaps on single stocks and similar references. None of them were cleared through a central counterparty at any of the monthly reporting dates in 2025, which run over 12 dates from January 31 to December 26. As of December 26, 2025, the outstanding notional amount of the TRS among them was about USD 3.33 trillion¹⁵. A TRS on a broad stock index falls into the "swap" category and is not included in these figures¹⁶.

When the share price moves, the side with a loss posts variation margin. In the TRS described in the SEC's complaint, if the price of the underlying stock fell, the party paying the equity return could call for variation margin to cover the mark-to-market loss. If the price rose, the party receiving the equity return could call for variation margin¹⁷. Separately, the dealer paying the equity return (Bank W in the example) guards against losses that future price moves could cause. For this, it asks the party receiving the equity return (Fund V) for initial margin. If the party receiving the equity return holds a large position in a single stock, the amount the dealer may fail to collect from that one firm grows. A sharp fall in the share price is when this happens.

Why large positions are hard to see

Because the dealer that hedges holds the shares, the party receiving the equity return does not appear as a holder of the shares. According to the SEC's complaint, Archegos, a family office (a firm that manages an individual's money), switched to TRS when its holdings of a stock approached 5% of the shares outstanding, the level at which US rules require holdings to be reported¹⁹. The same complaint states that each counterparty knew little about Archegos's positions with other financial institutions. It also states that in March 2021, the prices of stocks in which Archegos held large positions fell, Archegos could not meet large margin calls and defaulted, and its counterparty financial institutions suffered billions of US dollars in credit losses in total¹⁹¹⁸²⁰. In this case, family offices largely fell outside the regulatory perimeter and were not subject to entity-level reporting to authorities, and some jurisdictions had no rules requiring positions built with derivatives to be reported¹⁸. Hedge fund leverage and the credit management of those who provide it are covered in How Hedge Funds Use Derivatives.

For complianceJapan's large shareholding reports and cash-settled equity derivatives

Under the large shareholding reporting rules at that time, taking only the side receiving the equity return in a cash-settled equity derivative was generally considered not to be subject to reporting. This is the wording of a December 2023 report by a Financial System Council working group, which calls it holding only a "long" position (our translation). The same report says it is appropriate to make some trades subject to reporting, such as trades that assume a later switch to physical settlement and trades that use such positions to influence the issuer. As examples, it gives trades aimed at acquiring shares from the counterparty and trades aimed at influencing how the counterparty exercises the voting rights on the shares it holds²¹. This box is an explanation based on the report of the Financial System Council working group as of December 2023.

Notes

Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 4345.1, "Equity Derivatives," "Characteristics and Features," February 1998, page 1. ↩
Commodity Futures Trading Commission and U.S. Securities and Exchange Commission, "Further Definition of 'Swap,' 'Security-Based Swap,' and 'Security-Based Swap Agreement'" (2012, Release No. 33-9338), III.C, "Total Return Swaps," page 210, and footnotes 645 and 646. ↩ ↩²
Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 4350.1, "Credit Derivatives," "Total-Rate-of-Return Swaps," April 2003, page 1. ↩ ↩² ↩³
For simplicity, 3 months is treated as 0.25 years. In actual trades, the length of the period is counted using the day count convention of the interest side (such as Actual/360). ↩
For simplicity, the dividend is paid at the end of period 2. In the confirmation example, it is paid on the date shareholders receive the dividend ("Share Swap Transaction," March 1, 2007, "Dividends," "Dividend Payment Dates"). ↩
"Share Swap Transaction" (March 1, 2007, Exhibit 99.2 to a Schedule 13D on Endesa S.A. filed on EDGAR), "Equity Amounts." ↩ ↩²
"Share Swap Transaction," "Dividends," "Dividend Amount." ↩ ↩² ↩³
"Share Swap Transaction," "Floating Amount 1" and "Settlement Terms," "Final Price" and "Relevant Price." ↩
"Further Definition of 'Swap,' 'Security-Based Swap,' and 'Security-Based Swap Agreement'" (Release No. 33-9338), III.C, page 211. ↩ ↩² ↩³
"Further Definition of 'Swap,' 'Security-Based Swap,' and 'Security-Based Swap Agreement'" (Release No. 33-9338), footnote 649, page 211. ↩
Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 4345.1, "Equity Derivatives," "Uses," February 1998, pages 1–2. ↩
"Trading and Capital-Markets Activities Manual," Section 4345.1, "Uses," page 2. The manual's example floating rate, LIBOR, is no longer published (Financial Conduct Authority, "About LIBOR transition," the opening section). ↩
U.S. Securities and Exchange Commission, "Complaint, SEC v. Sung Kook (Bill) Hwang, et al." (April 27, 2022), paragraphs 36–37, page 9. ↩
"Complaint, SEC v. Sung Kook (Bill) Hwang, et al.," paragraph 120, page 27. ↩
U.S. Securities and Exchange Commission, "Report on Security-Based Swaps" (June 26, 2026), Table B.1, page 3, and Table D.1, page 11. The TRS figure for December 26, 2025 is USD 3,332,919 million. ↩
"Further Definition of 'Swap,' 'Security-Based Swap,' and 'Security-Based Swap Agreement'" (Release No. 33-9338), III.C, page 210, and footnote 647. ↩
"Complaint, SEC v. Sung Kook (Bill) Hwang, et al.," paragraphs 34–35, pages 8–9. ↩
Financial Stability Board, "Leverage in Nonbank Financial Intermediation: Final report," July 9, 2025, section 2.2, "March 2021, the default of Archegos," and footnote 9, pages 6–7. ↩ ↩² ↩³
"Complaint, SEC v. Sung Kook (Bill) Hwang, et al.," paragraphs 29–33, page 8; paragraphs 38–39, page 9; paragraphs 15 and 20, pages 5–6. ↩ ↩²
"Complaint, SEC v. Sung Kook (Bill) Hwang, et al.," paragraph 7, page 3. ↩
Financial Services Agency, "金融審議会公開買付制度・大量保有報告制度等ワーキング・グループ報告" (Report of the Financial System Council working group on the tender offer and large shareholding reporting rules) (in Japanese), December 25, 2023, "Ⅱ．大量保有報告制度のあり方について" (The large shareholding reporting rules), "３．デリバティブの取扱い" (Treatment of derivatives), and footnote 15, page 14. ↩