The Basics of American Depositary Receipts (ADRs)

American depository receipts are a type of investment with which many people are not familiar. This type of security can provide you with several advantages when investing. Here are the basics of the American depository receipt and how it can benefit you as an investor.

American Depository Receipts

An American depository receipt is a type of security issued by an investment bank. An investment bank will go overseas and purchase a certain number of shares in a foreign corporation. The bank will then offer shares that represent a certain number of shares in the foreign corporation. In this manner, American depositary shares essentially invest in a foreign company through a United States bank.

How They Are Traded

This type of investment is actually traded on a regular stock exchange. The bank sets up a certain ratio of American to foreign shares. For example, for each share that you purchase of the ADR, you will receive two shares in the foreign company. You are then free to buy and sell these shares on the stock market, just as you would a share of common stock. This makes trading foreign company shares just as simple as trading any other stock.

Benefits

This type of investment can be very attractive to domestic investors. Here are a few of the potential benefits that you can get by using an ADR.

One of the major benefits that you get is lower transaction costs. Typically, whenever you get involved in foreign stock markets, you will have larger transaction costs to worry about. You may have to pay a duty on each transaction that you make. By using an ADR, you will not have to be concerned with high transaction fees. In addition to this, the management that the investment bank provides will also save you money on costs.

Another advantage of investing in an ADR is convenience. This represents one of the easiest ways to get involved directly in foreign investments. Without using an ADR, you will have to work with a foreign stockbroker or another broker that specializes in foreign countries. You will have to worry about regulations and a lot of things that do not come into play when you use an ADR. By investing in an ADR, you have to know only how to buy and sell stock on an American stock exchange to get involved.

This type of investment also has great potential for you as an investor. There are many foreign countries that are in the middle of astounding growth. By using an ADR, you can tap into this growth and realize a nice return on your investment.

Risks

There are also a few risks involved when investing in an American depository receipt. Most notably, currency risk is something that you should be aware of. When a foreign company pays dividends, they will pay them in their own currency. This will then have to be converted to your currency, which involves some risk.

There is also political risk for you to be concerned about. You need to know whether the country in which you are investing is stable financially.

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