ABSTRACT

In March 1994, Procter and Gamble Inc. charged $157m against pre-tax earnings, representing the losses of two interest rate swaps. One risk measure designed to warn against the potential of large losses is value-at-risk (VaR). In this paper, the author conducts a value-at-risk analysis of one of the swap contracts. The VaR analysis is based on a one-factor Heath-Jarrow-Morton model of the term structure. The calculated VaR is approximately seven times the value of the contract. A complementary measure of risk (the 'conditional expected loss') is about ten times the value of the contract. An interesting by-product that emerges is that the one-factor model captured the yield curve evolution during that time rather well.