American Depositary Receipt (ADR)

A is correct. This scenario directly illustrates currency risk in ADRs. When the euro weakens from €1.00 = $1.10 to €1.00 = $1.05, each euro is worth fewer dollars. The €2.00 dividend that would have converted to $2.20 (€2.00 × $1.10) now converts to only $2.10 (€2.00 × $1.05). Jennifer receives less in USD despite the dividend amount in euros remaining constant. Currency risk exists because dividends are declared in the foreign currency before conversion.

B describes market price fluctuation, which is market risk, not currency risk. All exchange-traded securities experience intraday price changes. C addresses depositary fees, which are administrative costs, not currency risk. D discusses accounting standards, which creates analytical challenges but is not currency risk. Only A demonstrates how exchange rate movements directly impact the USD value of foreign currency dividends.

B is correct. An ADR is a negotiable security that represents shares of a foreign company deposited with a U.S. bank. The bank holds the actual foreign shares (either directly or through a foreign custodian) and issues ADRs that trade on U.S. exchanges in U.S. dollars. This structure allows American investors to own foreign stocks without needing international brokerage accounts or dealing with foreign currency transactions.

A is incorrect because it reverses the concept. ADRs bring foreign stocks to U.S. exchanges, not U.S. stocks to foreign exchanges. C is incorrect because ADRs represent actual ownership in foreign companies, not derivative positions or speculation contracts. D is incorrect because ADRs are individual securities representing specific foreign companies, not pooled investment vehicles like mutual funds.

B is correct. Calculate the USD dividend payment:

Dividend per share: £0.80
Exchange rate at payment: £1.00 = $1.30
USD dividend per share: £0.80 × $1.30 = $1.04
Total shares: 500 ADRs
Total USD received: $1.04 × 500 = $520

This demonstrates that currency movements directly impact ADR dividends. When the pound strengthened from $1.25 to $1.30, the investor benefited, receiving $520 instead of $500 (what they would have received at the $1.25 rate). Currency risk works both ways: favorable currency movements increase USD receipts, unfavorable movements decrease them.

A ($500) incorrectly uses the declaration rate and wrongly claims ADRs eliminate currency risk. C ($615) appears to be a calculation error with no clear basis. D ($650) uses an incorrect exchange rate ($1.30 per ADR instead of per pound) and incorrectly suggests dividends avoid currency risk.

B is correct (the EXCEPT answer). This statement is FALSE and represents the most common misconception about ADRs. ADRs do NOT eliminate currency risk. Even though ADRs trade in USD on U.S. exchanges, the underlying foreign stock is still denominated in a foreign currency. When the foreign company declares dividends in its home currency, those dividends must be converted to USD at the prevailing exchange rate. If the foreign currency weakens against the dollar between declaration and conversion, the USD dividend amount decreases. Currency risk is always present in ADR investments.

A is accurate: ADRs trade on U.S. exchanges (NYSE, Nasdaq, or OTC) in U.S. dollars, allowing U.S. investors to buy foreign stocks without needing international brokerage accounts. C is accurate: this is precisely why currency risk exists. dividends are declared in the foreign currency first, then converted to USD, exposing investors to exchange rate fluctuations. D is accurate: sponsored ADRs are established with the foreign company's cooperation and participation, while unsponsored ADRs are created by depositary banks without company involvement.

C is correct. Statements 2, 3, and 4 accurately describe a sponsored Level II ADR.

Statement 1 is FALSE: Only Level III ADRs can raise capital from U.S. investors through public offerings. Level II ADRs can list on major exchanges and have full SEC reporting, but they cannot conduct capital-raising activities. This is a key distinction between Level II and Level III ADRs.

Statement 2 is TRUE: Level II ADRs are listed on major U.S. exchanges (NYSE or Nasdaq), unlike Level I ADRs which trade only on OTC markets. This exchange listing provides greater visibility, liquidity, and prestige for the foreign company.

Statement 3 is TRUE: The "sponsored" designation means the foreign company actively participates in establishing and maintaining the ADR program. The company works with the depositary bank, pays program costs, and provides shareholder services. This contrasts with unsponsored ADRs, where banks create the ADR without company involvement.

Statement 4 is TRUE: Level II ADRs require full SEC reporting compliance, including Form 20-F (the foreign equivalent of Form 10-K). This provides U.S. investors with comprehensive financial disclosure similar to domestic companies, though Level II ADRs still cannot raise capital like Level III.