Case study Essay Example | Topics and Well Written Essays - 500 words - 60

Case study - Essay Example The deal was going on well with the company making small losses and gains to balance the losses, an indication that all systems were right. However, in mid April 1994, Artzt, the chairman of P & G, made a shocking revelation that the company had made a whopping $157 million loss after liquidating two interest rate swap contracts (Smith, 68). This was in addition to a $102 million after tax charge against the company’s third quarter profits to cover the losses incurred in the transaction (Malkin, 1994). The scenario was that P $ G had a signed a contract that considerably magnified the interest rates swings in a 3 years swap in which the company paid a floating rate on Libor (Smith, 69). The intention of the company was to make an interest in the event that interest rates fell or remained constant, which could have led the prices of the relevant bonds increasing or remaining constant. As a result, the company could have paid the expected Libor rate while still benefiting from t he income from Bankers Trust for the options. However, the short interest rates rose significantly leading to a decline in the prices of the long term bonds, forcing P & G to buy the derivatives at rates way above the selling value. In other words, P &G found itself paying rates above the selling value due to the sensitivity of the long term bonds to the slightest movement in interest rates. Consequently, P & G had to pay much higher to purchase back the derivatives from Bankers Trust than what the bank had paid for them due to the increase in the value of the options held by the bank as a result of a rise in interest rates (Heffernan, 641). P & G incurred the above losses due to interest rates volatility in the market, which made the company buy its swiped instruments at much higher costs than the bank had paid. The outcome of the transaction was that two P & G employees considered to bear the