ADR (American Depositary Receipt)
An ADR is a certificate issued by a U.S. bank representing shares in a foreign company, allowing American investors to buy foreign stocks on U.S. exchanges in U.S. dollars without dealing with foreign exchanges or currencies.
Exam Tip
ADR = foreign stock on U.S. exchange in USD. Level I = OTC. Levels II/III = major exchanges. Currency risk still applies!
What is an ADR?
An American Depositary Receipt (ADR) is a negotiable certificate issued by a U.S. depositary bank that represents shares of a foreign company's stock. ADRs trade on U.S. exchanges in U.S. dollars, making it easy for American investors to invest in foreign companies.
How ADRs Work
| Step | Description |
|---|---|
| 1 | Foreign company deposits shares with a custodian bank abroad |
| 2 | U.S. depositary bank issues ADRs representing those shares |
| 3 | ADRs trade on U.S. exchanges (NYSE, NASDAQ, OTC) |
| 4 | Dividends are converted to U.S. dollars and paid to ADR holders |
ADR Levels
| Level | Description | SEC Registration | Exchange |
|---|---|---|---|
| Level I | Minimal requirements | Exempt | OTC only |
| Level II | Full SEC reporting | Form 20-F | NYSE, NASDAQ |
| Level III | Can raise capital | Full registration | NYSE, NASDAQ |
| 144A | Private placement | Limited | QIBs only |
ADR Ratio
ADRs don't always represent a 1:1 ratio with foreign shares:
- 1 ADR = 1 foreign share
- 1 ADR = 10 foreign shares
- 10 ADRs = 1 foreign share
This is adjusted to keep ADR prices in a "normal" trading range.
Benefits of ADRs
| Benefit | Explanation |
|---|---|
| Convenience | Trade during U.S. market hours |
| Currency | Priced and pay dividends in USD |
| Familiarity | Trade on U.S. exchanges |
| Settlement | Standard U.S. settlement (T+1) |
| Diversification | Access to international markets |
Risks of ADRs
| Risk | Description |
|---|---|
| Currency Risk | Exchange rate fluctuations affect returns |
| Political Risk | Foreign government instability |
| Information Risk | Less transparency for some companies |
| Fees | Custodian fees may apply |
ADR vs. Ordinary Shares
| Factor | ADR | Ordinary (Foreign) Shares |
|---|---|---|
| Trading Location | U.S. exchanges | Foreign exchanges |
| Currency | USD | Local currency |
| Trading Hours | U.S. hours | Foreign hours |
| Custody Fees | Yes (small) | No |
Popular ADR Examples
- Toyota (TM)
- Alibaba (BABA)
- Novartis (NVS)
- Sony (SONY)
- BHP Group (BHP)
Exam Alert
ADRs allow U.S. investors to buy FOREIGN stocks on U.S. exchanges in USD. Know the 3 levels and that currency risk still applies. Sponsored ADRs have company involvement; unsponsored do not.