An American Depositary Receipt (ADR) is a certificate issued by a U.S. bank that represents ownership in shares of a foreign company. Instead of buying shares directly on a foreign exchange (in another currency, under foreign regulations), Americans can buy ADRs on U.S. exchanges in U.S. dollars.
The big picture: ADRs make it easy for U.S. investors to own foreign stocks. They're one of the most practical tools for international diversification.
---
1. A foreign company (say, Toyota in Japan) wants U.S. investor money 2. A U.S. depositary bank (like JPMorgan, Citibank, or Bank of New York Mellon) buys shares of Toyota in Japan 3. The bank holds those shares in a custodian bank in Japan 4. The U.S. bank issues ADRs representing those shares and sells them on U.S. exchanges 5. U.S. investors buy ADRs through their normal brokerage account in dollars
> Example: Samsung shares trade at ~₩70,000 per share (Korean won, roughly $50). A U.S. bank might structure an ADR where 1 ADR = 0.5 Samsung share, trading at ~$25 on NYSE. This makes Samsung accessible to U.S. investors who want to buy round lots.
---
Sponsored ADR The foreign company actively participates in and supports the ADR program. The company signs a deposit agreement with the U.S. bank and often provides financial reports in English. Most large, well-known foreign company ADRs are sponsored.
Unsponsored ADR The U.S. bank creates the ADR without the foreign company's cooperation. Multiple banks may create different ADR programs for the same foreign stock. Less common today, but still exists.
---
| Level | Exchange Listing | Capital Raising | SEC Requirements | |-------|-----------------|----------------|-----------------| | Level I | OTC only | No new capital raised | Minimal (Form F-6) | | Level II | NYSE, NASDAQ, AMEX | No new capital raised | Full SEC reporting (Form 20-F) | | Level III | NYSE, NASDAQ, AMEX | Yes — can raise new U.S. capital | Most stringent (full SEC reporting + registration) |
> Key exam point: Only Level III ADRs allow the foreign company to raise new capital from U.S. investors through public offerings.
---
Currency Risk Even though you buy ADRs in dollars, the underlying shares are priced in a foreign currency. If that currency weakens vs. the dollar, your ADR loses value even if the foreign stock price is flat.
> Example: You buy a British company ADR when £1 = $1.40. The company's stock stays flat in pounds, but the pound weakens to £1 = $1.20. Your ADR is worth less in dollars, even though nothing changed for the company's business.
Political/Country Risk Foreign governments can impose currency controls, expropriate assets, or change tax treaties. Investments in emerging markets carry higher political risk.
Information Risk Financial statements may be in a foreign language, follow different accounting standards (IFRS vs. GAAP), or provide less disclosure than U.S. companies.
Dividend Currency Conversion Dividends from the foreign company are paid in local currency → converted to dollars by the depositary bank → paid to ADR holders in dollars. The amount you receive depends on the exchange rate at the time of conversion.
---
---
---
Quiz Questions:
Q1. A U.S. investor holds ADRs representing shares of a German automobile company. The company's stock price in euros is unchanged, but the euro has depreciated 10% against the U.S. dollar. What is the likely impact on the ADR price?
A) No impact — ADRs are denominated in dollars so currency movements don't affect them B) The ADR price rises because a weaker euro makes German exports more competitive C) The ADR price falls approximately 10% because the underlying euros are worth fewer dollars D) The ADR price rises 10% because the depositary bank hedges currency risk
Answer: C — ADRs trade in dollars, but the value is tied to the underlying foreign shares priced in foreign currency. If the euro weakens 10%, those euros convert to fewer dollars. The ADR price falls roughly 10% even if the German stock was flat in euros. Currency risk is a real risk for ADR investors.
---
Q2. A foreign company wants to list shares on the New York Stock Exchange AND raise new capital from U.S. investors through a public offering. Which ADR level must the company use?
A) Level I B) Level II C) Level III D) Any level allows capital raising
Answer: C — Only Level III ADRs allow the foreign company to raise new capital from U.S. investors. Level I trades OTC with minimal SEC requirements and raises no new capital. Level II lists on exchanges but also raises no new capital. Level III requires the most stringent SEC registration and reporting.
---
Q3. What is the primary distinction between a sponsored and an unsponsored ADR?
A) Sponsored ADRs trade on stock exchanges; unsponsored ADRs trade OTC only B) Sponsored ADRs are created with the cooperation of the foreign company; unsponsored are created by a U.S. bank without the foreign company's involvement C) Sponsored ADRs pay dividends in foreign currency; unsponsored pay in U.S. dollars D) Sponsored ADRs represent one foreign share each; unsponsored can represent multiple shares
Answer: B — The key distinction is the foreign company's involvement. Sponsored = foreign company participates, signs a deposit agreement, often provides English-language financials. Unsponsored = a U.S. bank creates the ADR without the company's cooperation. Multiple banks can issue unsponsored ADRs for the same foreign stock.
---
Q4. A U.S. depositary bank structures an ADR so that each ADR represents 5 shares of a foreign company. The foreign shares trade at the local-currency equivalent of $8 per share. What is the expected ADR price?
A) $8 B) $1.60 C) $40 D) $16
Answer: C — ADR price = number of foreign shares represented × foreign share price = 5 × $8 = $40. Banks adjust the ratio to trade the ADR at a price range convenient for U.S. investors. In this case, 5:1 brings the effective price from $8 to $40.
---
Q5. An investor in an ADR receives a dividend. Which of the following correctly describes how the dividend is paid?
A) Dividends are paid in the foreign company's local currency and must be converted by the investor B) Dividends are paid by the foreign company directly to each ADR holder in U.S. dollars C) The depositary bank collects dividends in the foreign currency, converts to U.S. dollars, and distributes to ADR holders D) ADR investors do not receive dividends; only direct foreign shareholders do
Answer: C — The depositary bank acts as an intermediary: it collects dividends from the foreign company in local currency, converts them to U.S. dollars at the prevailing exchange rate, deducts any applicable foreign withholding taxes, and distributes the net dollar amount to ADR holders. This is one of the key services the depositary bank provides.