Total return swaps (TRS) rarely appear in the pages of Cutting Edge. This is partly because they do not require complex pricing models. However, their valuation is still affected by a number of factors beyond the underlying dynamics – among them, collateral funding costs, counterparty risk, regulatory asymmetries and taxation.
This last variable has largely been overlooked in the literature and in practice, which might be a costly mistake, as it can often mean the difference between a profitable deal and a loss-making one.
“The impact of taxation effects varies greatly depending on several factors, such as a portfolio’s composition, direction of trade, tax regime and rates. We noticed in some circumstances it is comparable to that of the TRS spread itself,” says Stefano Scoleri, a quantitative analyst at Be Consulting in Milan.
The full article is available at https://www.risk.net/our-take/7652366/mind-the-tax-when-hedging-trs