ADR - American Depositary Receipts

Definition

American Depositary Receipts (ADRs) are financial instruments that represent shares of foreign companies traded on U.S. exchanges. They simplify the process for American investors to buy shares in foreign companies by allowing them to purchase ADRs in U.S. dollars, making international investment more accessible and efficient. Each ADR typically represents a specific number of underlying foreign shares, and they are subject to U.S. regulations, providing a layer of security for investors.

5 Must Know Facts For Your Next Test

1. ADRs allow U.S. investors to invest in foreign companies without dealing with foreign currencies or international trading complexities.
2. There are two types of ADRs: Level I, which can only trade over-the-counter and do not require SEC registration, and Level II or III, which can be listed on major exchanges and require compliance with full SEC reporting requirements.
3. ADRs can enhance portfolio diversification by providing access to industries and companies not available in the U.S. market.
4. The price of an ADR is influenced by the underlying stock price in the home country, but also factors like currency exchange rates and market demand.
5. Tax implications for ADR holders may differ from domestic investments, including potential withholding taxes on dividends from the underlying foreign shares.

Review Questions

• How do American Depositary Receipts (ADRs) facilitate international portfolio investment for U.S. investors?
  • ADRs simplify the process of investing in foreign companies by allowing U.S. investors to purchase shares in dollars without the need for currency conversion or navigating foreign markets directly. This accessibility enables investors to diversify their portfolios with international assets while benefiting from the regulatory framework of U.S. markets. By holding ADRs, investors gain exposure to global growth opportunities while minimizing some complexities associated with cross-border investments.
• Compare Level I and Level II ADRs in terms of trading capabilities and regulatory requirements.
  • Level I ADRs trade over-the-counter and do not require registration with the SEC, making them less regulated and suitable for smaller foreign companies looking for a simpler entry into the U.S. market. In contrast, Level II ADRs are listed on major exchanges and must comply with full SEC reporting requirements, offering greater visibility and credibility. The distinction impacts how investors perceive these instruments regarding risk and potential for investment returns.
• Evaluate the impact of currency fluctuations on the performance of American Depositary Receipts and their attractiveness for investors seeking international exposure.
  • Currency fluctuations can significantly impact the value of ADRs, as they represent foreign stocks whose prices are influenced by exchange rates between the U.S. dollar and the local currency of the underlying company. If the local currency strengthens against the dollar, the value of an ADR may rise even if the underlying stock does not perform well. Conversely, if the local currency weakens, it could diminish returns for U.S. investors despite good performance by the underlying company. This volatility makes understanding currency dynamics crucial for investors considering ADRs as part of their international investment strategy.

Related terms

Depositary Bank: A financial institution that issues ADRs on behalf of foreign companies and holds the underlying shares in trust.

Global Depositary Receipts (GDRs): Similar to ADRs, but GDRs can be traded on international markets outside the United States, representing shares from multiple countries.

Foreign Direct Investment (FDI):

An investment made by a company or individual in one country in business interests in another country, often involving controlling ownership of a business.