Case study
The Endesa Equity-Linked Note

by Prof. Ian H. Giddy, New York University

A client is looking for innovative funding sources. They have heard about a debt issue of Endesa, the Spanish utility, that Banco Santander placed in Argentina. (See attached article.)
  • Please explain, by means of diagrams, how the deal would work. 
  • What derivatives are needed to make this work? 

  • What is the economics of it? (In other words, how could it be structured in such a way to satisfy the investor and at the same time save money for the issuer?)

Derivatives Week, February 3, 1997

Endesa Issues Latam Equity-Linked Bond

International Endesa, a Netherlands-based company owned by Empresa Nacional de Electricidad in Madrid, has launched a USD26.5 million U.S. dollar-denominated five-year bond linked to the performance of a basket of Latin American shares, according to Pedro Corpas, subdirector of international finance in Madrid. The note, structured by Santander Financial Products and sold to Argentinean pension funds, is the first equity-linked bond to be issued by a foreign company in Argentina and sold to local pensions, said Javier Epstein, v.p.-marketing at Santander FP in New York. Santander FP provided Endesa with the hedge through a five-year equity swap that mirrors the bond’s payout and converts the bond’s U.S. dollar cash flows into French francs, Corpas said.

The company converted the bond’s U.S. dollar cash flows into francs because the franc has a higher correlation to the Spanish peseta than the U.S. dollar, Corpas added. The bond allows Endesa to finance itself without incurring a substantial currency risk, he said, noting that in the swap, Endesa pays a floating rate in French francs.

The five-year zero-coupon principal-protected bond, which is listed in London, is linked to a basket of Latin American shares and pays, at maturity, a variable interest rate based on the basket’s monthly average appreciation during the life of the bond, Epstein said. The Asian options allow investors to participate in the upside during the five years instead of only at one point during the bond’s life. The equally-weighted basket is composed of the top five shares in Mexico, Brazil, Argentina and Chile, Epstein noted, adding that the investment-grade bond gives pensions exposure to other emerging markets.

Luis Rocco, head of portfolio managers at local pension fund manager Siembra AFJP with USD800 million in assets under management, said the note provides Siembra exposure to the equity markets of other Latin American countries, adding that local regulation limits pensions’ direct participation in international markets. However, the note may have had a better risk/return profile if the guarantor had been a local company, he noted, adding that although the average-rate feature made the embedded options less expensive, it also complicated the note’s payout. | | | | | contact

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