What is American Depository Receipt (ADR):
ADR is a negotiable instrument like a stock issued by The US depository bank to domestic buyers as an entitle for ownership of this stock in foreign companies. It represents the ownership in the shares of a foreign company trading on the US stock market. ADR’s gives an investor a good way to diversify your risk geographically. They float on supply and demand just like the regular stocks. Through the use of ADR’s the stocks of many non-US exchanges through the use of ADR. They are one of the most convenient ways for investors to buy stocks of companies outside the US.
Many foreign companies find it very expensive and inconvenient to directly list their shares on the US Stock exchange. To avoid that they go for ADR’S.
Types of ADR’s issue:
Level 1: They are usually traded Over-The-Counter. It’s also an easy and inexpensive way to earn interest from securities in North America. They don’t wish or either qualify to have their ADR’s listed on exchanges.
Level 2: They have more requirements compared to level1 to be listed from SEC(Securities and Exchange Commission). It has higher visibility. These level2 ADR’s are listed on an exchange or quoted on NASDAQ.
Level 3: They have the highest visibility in the US financial markets. They can raise capital that is can make, a public offering. It is the most prestigious one.
How does it work?
- US banks purchase a bulk lot of shares from the company.
- Banks bundle up these shares into groups and reissues them on either The New York Stock Exchange or American Stock Exchange (AMEX) or the Nasdaq.
- The depository bank sets the ratio of US. ADR’s per home country share. This ratio can be anything less than or greater than 1. (This is done because the banks wish to price an ADR high enough to show essential value, yet low enough to make it cost-effective for individual investors
Benefits of ADR:
- It is one of the cheapest and affordable way to purchase shares in a foreign company. They save money by reducing administration cost.
- Foreign tax being levied on each transaction is reduced and also access to all the emerging markets like Chinese, Indian, Brazilian stocks.
- The company gets more exposure In the US market, allowing them to make use of opportunities into the wealthy North American markets.
- There is no stamp duty for Irish and European investors in terms of investment in shares listed on the US stock markets.
- It is much cheaper to buy and sell shares online in US markets than European Markets.
Downside of ADR’s:
- Political Risk: If an investment is made in ADR for a company. You need to check if the government in the home country of ADR is stable.
- Exchange Rates: You need to check if the currency of the home country is stable. If a country’s currency is devalued. It will affect your ADR. Even if the company’s performance is stable, this will result in huge losses.
Since it provides a diversification to invest not only in stocks but also in different countries as well, you are provided with a great opportunity to invest and capitalize on many emerging economies at an affordable cost.