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Now that you've learned how an ADR is established and sold to the public, let's delve a little deeper. In this section, we'll examine how the price of an ADR is determined.
Let's use an example to give you a better idea of how the ADR process works. Suppose a recent boom in the popularity of Bloody Mary drinks has increased the prospects for the vodka industry. Russian Vodka Inc. wants to list shares on the NYSE to gain exposure to the U.S. market and to tap into the growing demand for vodka.
Russian Vodka already trades on the Russian Stock Exchange at 127 Russian roubles, which, at this time, is equivalent to US$4.58. Let's say that a U.S. bank purchases 30 million shares from Russian Vodka Inc. and issues them in the U.S. at a ratio of 10:1. This means each ADR share you purchase is worth 10 shares on the Russian Stock Exchange. A quick calculation tells us that the new ADR should have an issue price of around US$45.80 each (10 times $4.58).
Once an ADR is priced and sold on the market, its price is determined by supply and demand, just like an ordinary stock. However, if the U.S. price varies too far from the Russian price after taking the currency exchange rate and the ratio of ADRs to home country shares into account, an arbitrage opportunity may arise. ADRs tend to follow the general trend of the home country shares, but this is not always the case.
ADRs present many other unique risks to investors; we'll examine these in the following section.
Next: ADR Basics: Risks »
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