American Depositary Receipt

An American Depositary Receipt (ADR) is used to:

1. A.Facilitate U.S. trading of foreign company sharesCorrect - ADRs represent foreign shares.
2. B.Trade commoditiesCommodities trade as futures or physicals through entirely separate markets and account types. An ADR is an equity receipt, and what sits behind it is company shares rather than a physical good.
3. C.Finance municipal projectsFinancing public projects is the work of municipal bonds issued by state and local governments. An ADR raises capital for no one; it is a receipt for shares already outstanding abroad and held by a U.S. depositary bank.
4. D.Hedge currency onlyThere is something real here, since an ADR holder does carry currency exposure through the foreign underlying. But the instrument exists to give U.S. investors access to that foreign equity, and the word only promotes an incidental side effect into the purpose.

Why: ADRs facilitate U.S. trading of foreign company shares, denominated in dollars.

A new client brings Ardwyn Sarre, an agent at Pentland Crest Securities, four holdings and asks which of them the Uniform Securities Act treats as a security: an American depositary receipt for shares of a Japanese manufacturer; a fixed annuity contract issued by an authorised insurer; a December wheat futures contract; and a twenty year level term life insurance policy.

1. A.The twenty year level term life insurance policyAn insurance policy with a fixed benefit and no separate account is not a security.
2. B.The American depositary receiptCorrect. A receipt for or certificate of interest in a security is itself a security under the Act.
3. C.The December wheat futures contractCommodity futures contracts are outside the definition of security under the Uniform Securities Act.
4. D.The fixed annuity contractThe insurer guarantees the rate and bears the investment risk, so a fixed annuity is not a security.

Why: The definition of security includes receipts for and certificates of interest in other securities, which is exactly what an American depositary receipt is. A fixed annuity places the investment risk on the insurer and is not a security. A commodity futures contract is not a security under the Act. A term life policy with no separate account and no investment element is likewise not a security.

An American depositary receipt (ADR) allows a U.S. investor to:

1. A.Purchase U.S. company shares on foreign exchangesThis is backwards: ADRs bring FOREIGN shares to U.S. markets, not U.S. shares abroad.
2. B.Own an interest in foreign shares that trades in U.S. markets in dollars, while still bearing currency riskCorrect. The ADR wraps foreign shares for U.S. trading convenience; currency fluctuations still flow through to value and dividends.
3. C.Avoid foreign tax withholding on dividends paid by the issuerForeign governments typically withhold tax on dividends before they reach ADR holders; the wrapper does not exempt them.
4. D.Eliminate foreign-currency risk by holding dollar-denominated receiptsThe dollar price of the ADR itself moves with the exchange rate - denomination does not remove currency exposure.

Why: An ADR is a U.S.-traded, dollar-denominated receipt representing shares of a foreign company held by a custodian bank. It simplifies access - but dividends originate in the foreign currency, so exchange-rate risk remains. The clue: ADRs change the trading wrapper, not the underlying economics. Review: Equity and Debt Securities.

An investor holds American Depositary Receipts (ADRs) of a foreign company. Which risk is most specifically associated with ADRs?

1. A.Mandatory currency hedging by the holderWrong. Hedging is optional, not mandatory.
2. B.Guaranteed loss of voting rights in all casesWrong. Voting arrangements vary; loss of voting is not universal or the defining ADR risk.
3. C.FDIC assessment riskWrong. ADRs are securities, not FDIC-insured deposits.
4. D.Currency exchange-rate riskCorrect. Currency risk is specific to foreign-share instruments like ADRs.

Why: ADRs represent foreign shares held by a U.S. depositary bank and trade in U.S. dollars, but the investor still bears currency (exchange-rate) risk because the underlying is denominated in a foreign currency. Citation: NASAA Series 65 outline, equity securities. Takeaway: ADRs = foreign shares with currency risk.