Quick Answer
American Depositary Receipts (ADRs) are certificates issued by a United States depositary bank that let investors buy foreign company shares on United States exchanges in dollars. Sponsored ADRs are created with the foreign company's cooperation; unsponsored ADRs trade over-the-counter only. Owning an ADR carries currency, tax, and political risk.
So far, every equity security we've covered has been issued by a U.S. corporation. But what if you want to invest in a foreign company without dealing with foreign exchanges and currencies? That's where ADRs come in.
What Are ADRs?
- American Depositary Receipts (ADRs) are certificates issued by a U.S. depositary bank representing shares of a foreign company
- Trade on U.S. exchanges in U.S. dollars
- Dividends are paid in U.S. dollars (the depositary bank converts from the foreign currency)
- Allow U.S. investors to invest in foreign companies without using foreign brokers or exchanges
Key Risks
- Currency (exchange rate) risk - changes in foreign exchange rates affect both the ADR's value and dividend payments
- Foreign tax withholding - foreign governments may withhold taxes on dividends (investors may claim a foreign tax credit on their U.S. tax return)
- Political risk - foreign government actions can affect the underlying company
Exam Tip: Gotchas
- ADRs trade in U.S. dollars but still carry currency risk. The underlying shares are denominated in a foreign currency, so exchange rate changes still affect the ADR's price and dividend payments.
- Example: a German company's shares are unchanged at 100 euros. At $1.10 per euro, those shares convert to $110. If the euro weakens to $1.00 per euro, the same 100-euro shares convert to only $100, even though nothing changed in euro terms.
- Foreign tax withholding does not mean double taxation. Investors can typically claim a foreign tax credit on their U.S. return to offset taxes withheld by the foreign government.
- Eurodollar bonds, Yankee bonds, and currency ETNs are not equity. These three appear as common distractors in ADR questions. A Eurodollar bond is a dollar-denominated bond issued outside the U.S. A Yankee bond is a dollar-denominated bond issued inside the U.S. by a foreign entity.
- Both bonds are debt: the investor lends money and earns interest, with no ownership stake in the company. A foreign currency ETN tracks exchange rates, not company stock. None of these gives equity exposure to a foreign company the way an ADR does.
Sponsored vs. Unsponsored ADRs
| Feature | Sponsored | Unsponsored |
|---|---|---|
| Created with | Foreign company's cooperation | Without issuer involvement |
| Listing | May trade on major U.S. exchanges (NYSE, Nasdaq) | Over-the-counter (OTC) markets only |
| SEC reporting | Higher-level programs file with SEC | Minimal SEC requirements |
| Investor protection | More transparent | Less investor protection |
| Depositary bank role | Company selects one depositary bank | Multiple banks may issue ADRs |
Exam Tip: Gotchas
- Unsponsored ADRs trade OTC only. They lack the foreign company's direct involvement and offer less investor protection than sponsored programs.
Think of it this way: A U.S. bank buys shares of a foreign company and then issues certificates (ADRs) that represent those shares. You buy and sell the certificates on a U.S. exchange in dollars, but behind the scenes, the actual shares are still priced in a foreign currency. That is why currency risk remains even though you never touch foreign money directly.
What Should You Check on Exam Day?
- Can you explain why an ADR still carries currency risk even though it trades in United States dollars?
- Do you know why foreign tax withholding on ADR dividends does not mean double taxation?
- Can you explain why Eurodollar bonds, Yankee bonds, and currency ETNs are not equity like an ADR?
- Do you know where unsponsored ADRs trade?