Credit Enhancement Through Targeted Risk Managment: Freeport-Mcmoran's Gold-Dominated Depository Shares

43 Pages Posted: 11 Nov 2008

See all articles by N.K. Chidambaran

N.K. Chidambaran

Fordham University - Gabelli School of Business

Chitru S. Fernando

University of Oklahoma - Michael F. Price College of Business

Paul A. Spindt

Tulane University - A.B. Freeman School of Business

Date Written: November 1998

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.

Keywords: Risk management, Gold-linked, Hybrid Securities

Suggested Citation

Chidambaran, N.K. and Fernando, Chitru S. and Spindt, Paul A., Credit Enhancement Through Targeted Risk Managment: Freeport-Mcmoran's Gold-Dominated Depository Shares (November 1998). NYU Working Paper No. FIN-98-087. Available at SSRN: https://ssrn.com/abstract=1298292

N.K. Chidambaran (Contact Author)

Fordham University - Gabelli School of Business ( email )

United States

Chitru S. Fernando

University of Oklahoma - Michael F. Price College of Business ( email )

Adams Hall
307 West Brooks Street
Norman, OK 73019-4004
United States
405-325-2906 (Phone)
405-325-7688 (Fax)

HOME PAGE: http://faculty-staff.ou.edu/F/Chitru.Fernando-1/

Paul A. Spindt

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States
504-865-5413 (Phone)

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