Credit Enhancement through Financial Engineering: Freeport-McMoRan's Gold-Denominated Depository Shares

N. K. Chidambaran, Chitru S. Fernando and Paul A. Spindt

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: In 1993 and early 1994, Freeport McMoRan Copper and Gold (FCX), a mining company, issued two series of gold-denominated depositary shares to raise 430 million dollars expanding their mining capacity in Indonesia. We price the depositary shares using a term structure model for the forward rates implied by gold futures and we show that FCX successfully enhanced the credit quality of the issue. This credit enhancement is achieved because the effect of linking the payoff of the depositary shares to gold reduces default risk and is similar to conventional risk management. However, the bundling of financing and risk management allows the firm to target hedging benefits only to the newly issued securities. The design of the security also overcomes the asset substitution problem. The depositary shares issued by FCX illustrate how firms can enhance credit quality through financial engineering without changing the existing priority ordering of their capital structure.

Keywords: Risk management; Gold-linked; Hybrid Securities (search for similar items in EconPapers)
JEL-codes: G13 G32 (search for similar items in EconPapers)
Date: 1999-06
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Citations: View citations in EconPapers (1)

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