Exposure to Market Sectors

To gain exposure to sectors where, for various reasons, they do not wish to make actual purchases, investors can use a variation on a TR swap called an index swap, in which one of the counterparties pays a total return tied to an external reference index and the other pays a LIBOR-linked coupon or the total return of another index. Indexes used include those for government bonds, high-yield bonds, and technology stocks. Investors who believe that the bank loan market will outperform the mortgt e-backed bond sector, for instance, might enter into an index swap in which they pay the total return of the mortgage index and receive the total return of the bank-loan index. 

Credit default swaps can be used to trade credit spreads. Say investors believe the credit spread between certain emerging-market government bonds and U.S. Treasuries is going to widen. The simplest way to exploit 

FIGURE 10.6 Total Return Swap Used in Capital Structure Arbitrage  

Bond total return plus LIBOR + 30bps 

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