Business and Personal Finance Dictionary

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• TOTAL RETURN OPTION
  
  Definition: A Put Option (q.v.) on debt with credit risk. Example: A customer fearing a default on his debt could pay a premium for a put option that allows him to sell a risky corporate bond at par if the corporation defaults on any of its debt. Application: See Credit Derivatives. Pricing: A standard model for pricing equity options would be a good starting place for pricing a Total Return Option. Risk Management: One might try to hedge this dynamically with the underlying risky debt. Comment: Pricing and hedging might be difficult, and market manipulation may be an issue for a thinly traded underlying instrument.
  
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