N. K. Chidambaran, Chitru S. Fernando, Paul A. Spindt
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 for expansion of 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. The building of financing and risk management, however,
allows the firm to target hedging benefits only to the newly issued
securities. The design of the security overcomes the asset substitution
problem and credibly commits the firm to hedging. 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.
Chidambaran: (212) 998-0318 chiddi@stern.nyu.edu
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