A depository receipt is a financial instrument that is traded on a local stock exchange but derives its value from the underlying which is listed on some other stock exchange in a foreign country. This security allows the investors to have a holding in security which is issued by a corporation incorporated in a foreign country. Hence a depository receipt is created when a company decides to list its already listed security, be it an equity or a debt instrument on a foreign stock exchange. Prior to getting listed on such foreign stock exchange, the impugned company will have to fulfill the various prerequisites which would be put forth by the exchange as well as the regulator. The receipts are freely tradeable on the exchange.
The most prevalently issued depository receipts are ADR’s and GDR’s.
The ADR’s or the American Depository Receipts are issued by the United States banks which are represented by an underlying specified number of securities which are listed on a foreign stock exchange. The ADR’s are denominated in U.S. dollars, and the investors in these depository receipts receive the distribution as well as the capital gains in the same ways as they are received by an ordinary shareholder of the company in the U.S. dollars. The ADR’s are typically listed on New York Stock Exchange or the NASDAQ but are also traded over-the-counter (OTC). The underlying securities based on which these ADR’s are issued are held by a financial Institution based out of United States of America. Before the introduction of the ADR’s if an American investor wanted to have exposure towards foreign security, then he simultaneously used to get exposed to the foreign exchange risks, as well as the administration and the duty costs levied on each transaction. However, with the introduction of these instruments, the risks have been somewhat mitigated, as the ADR’s are traded in US dollars & investors need not transact in the foreign currencies.
On the other hand, GDR’s are depository receipts which are issued by a Global financial institution in multiple countries for shares which are issued in a foreign country. These GDR’s are listed on the international exchanges such as the London Stock Exchange & Luxembourg Stock Exchange to name a few. The corporations may use the issuance of GDR’s to raise capital which is typically denominated in U.S. Dollars or Euros. Corporations issue these instruments in order to garner the interests of the fraternity of international investors. A custodian bank is generally engaged which takes the possession of the shares and then issues these securities to the investors, thus also providing the required confidence to both the parties involved.
Investments in the ADR’s and GDR’s have become pretty popular in the recent time as the same provides the needed diversification to the portfolio which in turn results into the stability of the returns derived from these portfolios.
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