Reading 34: Equity: Markets and Instruments-LOS f, (Part 2) because, 2010, buying, center, between

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Session 10: Equity Valuation: Valuation Concepts
Reading 34: Equity: Markets and Instruments

LOS f, (Part 2): Calculate the cost tradeoff between buying shares listed abroad and buying ADRs.

 

 

 

Arbitrage opportunities generally do not exist often because American Depository Receipts (ADRs) trade at:

A) higher prices to the underlying foreign company’s shares and are highly correlated to U.S. markets in rising markets.

B) parity to the underlying foreign company’s shares, except for the additional administrative costs for listing on a U.S. exchange.

C) parity to the underlying foreign company’s shares, except for higher foreign exchange currency costs.

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ADRs often trade at parity with very small differences mainly attributable to higher administrative costs. Foreign currency differences are generally factored in the ADRs.

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Belzinger Beer is an international brewery listed on the Paris Stock Exchange and has its American Depository Receipts (ADR) shares that trade on the U.S. NASDAQ. John Toga, CFA, a portfolio manager for the Europa Fund, wishes to purchase shares in Belzinger. The current exchange rate is USD1.15 for one euro. The current price on the Paris Stock Exchange is 34.68 euros, while the ADRs are trading at USD40.00. Brokerage commissions are 0.50% commission in Paris, while commissions in the U.S. are 0.75%. If John wishes to purchase shares in Belzinger at the lowest cost, what exchange should he trade on?

A) U.S. NASDAQ, for a savings of $0.22 per share.

B) Paris, for a savings of $0.22 per share.

C) Paris, for a savings of $5.15 per share.

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First, determine the cost of trading in the ADRs on the U.S. NASDAQ. USD40.00 + commissions (USD40 × 0.75% = USD0.30) = USD40.30 per share.

Second, determine the cost of trading on the Paris Stock Exchange: EUR34.68 + commissions (EUR34.68 × 0.50% = EUR0.17) = EUR34.85 per share. Convert to U.S. dollars at the current exchange rate = EUR34.85 × 1.15 = USD40.08

The savings would be greater in the Paris exchange. (USD40.30 ? USD40.08) = USD0.22 per share.

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Large institutional investors prefer to purchase shares of a foreign company in its local stock market primarily because of:

A) reduced administrative costs and lower foreign exchange currency risks.

B) better execution of prices and reduced trading risks.

C) lower costs and greater liquidity.

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Generally it is more costly for large institutional investors to purchase American Depository Receipts (ADRs) than to directly purchase the securities in the local markets since the local market may provide more liquidity.