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What is an 'American Depositary Receipt - ADR'

An American depositary receipt (ADR) is a negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in a foreign stock traded on a U.S. exchange. 

BREAKING DOWN 'American Depositary Receipt - ADR'

ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. Holders of ADRs realize any dividends and capital gains in U.S. dollars, but dividend payments in euros are converted to U.S. dollars, net of conversion expenses and foreign taxes. ADRs are listed on either the NYSE, AMEX or Nasdaq, but they are also sold over-the-counter (OTC).

American depositary receipts were introduced in 1927 as an easier way for U.S. investors to purchase stock in foreign companies. Non-U.S. companies also benefit from ADRs, as they make it easier to attract American investors. Before ADRs existed, if American investors wanted to purchase shares of a non-U.S. listed company, they had to buy the shares on international exchanges. Purchasing shares on international exchanges has potential drawbacks, particularly currency-exchange issues and regulatory differences. Publicly traded companies have to answer to regulatory bodies with jurisdiction over their country. In the United States, the regulatory body is the Securities Exchange Commission (SEC), which works to protect investors. The regulatory bodies implement and enforce rules on companies, including how companies should present pertinent financial information. Before investing in an internationally traded company, U.S. investors had to familiarize themselves with the different rules, or they could risk misunderstanding important information, such as the company's financials.

Benefits

ADR holders do not have to transact in foreign currencies, because ADRs trade in U.S. dollars and clear through U.S. settlement systems. The U.S. banks require that the foreign companies provide them with detailed financial information, making it easier for investors to assess the company's financial health compared to a foreign company that only transacts on international exchanges.

Trading ADRs

To offer ADRs, U.S. banks simply purchase shares from the international company and reissue them, typically on U.S. exchanges. An ADR may represent the underlying shares on a one-for-one basis, or it may represent a fraction of a share or multiple shares. The depositary bank sets the ratio of U.S. ADRs per home-country share at a value that appeals to investors. If an ADR’s value is too high, it could deter some investors, but if it is too low, investors may think the underlying securities resemble riskier penny stocks.

Numerous companies trade in the United States as ADRs. For example, Volkswagen trades OTC under the ticker VLKAY. BP Plc. trades on the NYSE under the ticker BP.

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