Risks
Stocks and bonds issued in countries outside the United States are considered riskier than domestic issues, but adding these investments to a portfolio can actually decrease the overall risk of the portfolio through added diversification. Here's what you need to know:
  • Emerging vs. developed markets
    • Developed markets include those countries with an established economy and securities market, such as most of Western Europe, Japan and Australia.

    • Stocks and bonds purchased from developed countries offer less risk than those from emerging markets, such as Latin America, Southeast Asia and much of Eastern Europe.

    • The potential returns from emerging market countries are attractive to investors with a tolerance for elevated risk.
The article What Is An Emerging Market Economy details emerging market economies and the potential rewards for investors willing to accept the additional risks.
  • Currency risk
    • Since foreign currencies can fluctuate against the U.S. dollar, an American investor may find the actual return on foreign investments to be enhanced or decreased.

    • When investors have assets in international investments, they face currency risk unless their positions are hedged.

    • The return earned by a U.S. investor with international investments is affected by both the change in the price of the investments and the foreign currencies' fluctuation against the dollar.

    • If the dollar strengthens compared to the foreign currency, the investor's returns suffer.

    • Since these exchange fluctuations are difficult to predict, currency exchange is an inherent risk in international investing.

  • Political risk
    • Foreign investments can be affected by wars and government actions, such as taxes or restrictions on currency exchange.

    • These factors tend to be a bigger risk in emerging market countries.

  • American Depository Receipts (ADRs)
    • Foreign corporations may choose to "list" their shares on U.S. stock exchanges by issuing ADRs.

    • This allows American investors to purchase the companies' shares without the companies having to register with the SEC.

    • Typically, a large U.S. bank with offices in the foreign country will purchase a large quantity of the stock, hold it in trust and then issue the ADRs, which are backed by the shares held in trust.

    • ADR purchasers receive no voting rights.

    • Dividends are declared in the foreign currency but converted and paid in U.S. dollars.
Thanks to ADRs, investors now have a world of investing opportunities to choose from. The tutorial ADR Basics examines these securities, as well as the associated risks and how their prices are determined.

Look Out!
Expect at least two questions on ADRs: typical incorrect answers include: "dividends are paid in the foreign currency", "ADR holders have voting rights like holders of any other stock" and "shares are held in trust at a foreign bank"
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Exam Tips and Tricks
Consider this sample exam question:
  1. The following statements about ADRs are all true, EXCEPT:
    1. They trade on U.S. stock exchanges.
    2. They enable U.S. investors to easily purchase international stocks.
    3. They pay dividends in the currency of the originating country.
    4. They represent shares of foreign securities held in trust in U.S. banks.
The correct answer is "c". ADRs pay dividends in U.S. dollars.
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