American Depositary Receipts allow US investors to invest in foreign stocks on American stock exchanges using US dollars, avoiding administrative and duty costs. A US or international bank buys shares in a foreign company, creates the ADR, and charges a management fee. The bank often partners with a custodian bank to handle day-to-day operations. ADRs allow for regional diversification and access to the best companies worldwide.
An American depository receipt is a means for American investors to easily invest in foreign stocks. An American Depositary Receipt trades on American stock exchanges in US dollars. However, its value depends on how the foreign stock is represented by the American depositary receipt on the foreign currency in which the stock is quoted.
A US bank or international bank buys a number of shares in a foreign company. Then it creates a financial instrument, the American Depositary Receipt, to be sold on a publicly traded exchange in the United States. Investors in the United States can then indirectly invest in this foreign company using US dollars. This allows the American investor to avoid a large amount of administrative and duty costs that would be incurred if the foreign stocks were held directly.
The US or international bank charges a management fee, which is included in the price of the US depositary receipt, or receives a fee from the foreign company. In the latter case, the foreign company is willing to pay for the benefit of exposure to a much larger market, the American market.
The US bank that creates the American Depositary Receipt also often partners with a second US bank. The bank that initiates the process is usually a large investment bank that specializes in large-scale investments. This investment bank will partner with a custodian bank that can specialize in the day-to-day business of buying and selling every single American depository receipt and paying any dividends. This arrangement allows the investment bank to specialize in what it does best and the custodian bank to focus on its area of expertise. Both functions are needed, and even very large banks may not have or wish to have all of the required skills internally.
American investors can use an American depositary receipt as an easy way to regionally diversify their investments. It often happens that the economy in one region of the world is booming while another region is in recession. By investing in a number of regions, the investor expects overall portfolio returns to be more consistent. American Depository Receipts also make it easy for American investors to invest in the best companies in the world, no matter what world market they trade on.
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