Aggressive Corporate Finance: A Close Look at the Procter & Gamble-Bankers Trust Leveraged Swap

Abstract

The leveraged interest rate swap transacted between Procter & Gamble and Bankers Trust in November 1993 is one of the infamous "derivatives debacles" of 1994. This article examines that transaction in detail, demonstrating that P&G in the swap was effectively writing embedded options on Treasury securities in order to lower its anticipated cost of borrowed funds.While the premium and the payout on the options are expressed in a complex formula that set the terms of the swap, P&G's market risk on the transaction is not difficult to estimate - and was not difficult at the time. It appears that, for the risk it took on in writing the embedded options, P&G received only about one-third what it could have collected if the options were instead sold on Treasury futures contracts at the Chicago Board of Trade. The author suggests that the difference between the anticipated accounting treatment on a leveraged swap and on traded options is a key factor in understanding why P&G entered the leveraged swap.

JEL Classification: G13, G11, G21