A U.S. retail investor purchases sponsored American Depositary Receipts (ADRs) of a foreign telecommunications company listed on the New York Stock Exchange. When evaluating the rights, mechanics, and risk profile associated with owning these securities compared to domestic common stock, which of the following statements accurately describes a key characteristic of ADR ownership?
- Dividends are declared by the foreign issuer in foreign currency but paid to the ADR holder in U.S. dollars, exposing the investor to exchange rate risk.Answer
- BADR holders maintain direct voting rights and receive preferred liquidation priority over foreign common shareholders in the event of corporate dissolution.
- CBecause ADRs are denominated and traded in U.S. dollars on U.S. exchanges, holders are completely insulated from foreign currency risk.
- DThe depositary bank automatically passes through all foreign preemptive rights offerings directly to U.S. investors without pre-conversion.
Answer
Dividends are declared by the foreign issuer in foreign currency but paid to the ADR holder in U.S. dollars, exposing the investor to exchange rate risk.
The option stating that dividends are declared in foreign currency but paid in U.S. dollars is correct. Sponsored ADRs allow U.S. investors to trade foreign equities domestically, but because the underlying foreign issuer generates revenue and declares distributions in its home currency, the depositary bank must convert payments to U.S. dollars. This subjects the U.S. investor to currency exchange rate risk.
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Key Concept
American Depositary Receipts (ADRs) Equity Characteristics and Currency Risk