Journal Questions

Question – 1

Prepare journal entries, general ledger, trial balance, income statement, and balance sheet for the following scenarios.

ADR Conversion to Local Equity Shares—BRL
Mark Antony Inc. traded in Bovespa shares in a Brazilian Stock Exchange through Henry Frank Brothers brokers and the details are as follows.

Trade Details
Date                    Product               CCY                  Quantity           Rate             B/S               Brokerage
15-Jan-X1       Bovespa—ADR        US$                    9,000            32.00              B                 US$ 900
28-Jan-X1       Bovespa—ADR        US$                    5,000            35.00              B                 US$ 525
5-Feb-X1        Bovespa—Local       BRL                  15,000            28.50              S                  BRL 1,280

Other Details
One ADR converts to two local shares in BRL currency.
Settlement: T + 2.
Conversion fees levied by broker to convert ADR shares into local shares for 7,500 ADRs amounts to $1,300.
Functional currency is US$.

Liquidation Methodology
FIFO

FX Rates
Date                   FX Rate
11-Jan-X1         1.6505
13-Jan-X1         1.6525
25-Jan-X1         1.6484
27-Jan-X1         1.6444
31-Jan-X1         1.6311
5-Feb-X1          1.6255
7-Feb-X1          1.6201
28-Feb-X1        1.6150

Market Rate
Bovespa ADR
January 31: $33.50
February 28: $38.00
Bovespa Local
January 31: BRL 26.25
February 28: BRL 32.50

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Question – 2

ADR Conversion to Local Equity Shares—MXN

Mexico Opportunities Fund traded in America Movil shares in a Mexican Stock Exchange through Goldman Sachs and the details are as follows.

Trade Details
Date                  Product                       CCY          Quantity          Rate             B/S Brokerage
12-Jan-X1      America Movil—ADR     US$              1,500            51.50            B US$ 200
22-Jan-X1      America Movil—ADR     US$              3,500            52.50            B US$ 700
24-Jan-X1      America Movil—ADR     US$              1,800            53.50            S US$ 260
5-Feb-X1       America Movil—Local    MXN           30,000            57.50           S MXN 5,200

Other Details
One ADR converts to 10 local shares in MXN currency.
Settlement: T + 2.
Conversion fees levied by broker to convert ADR shares into local shares amount to $810.
Functional currency is US$.

Liquidation Methodology
Weighted average

FX Rates
Date                FX Rate
11-Jan-X1     10.6505
13-Jan-X1     10.6525
25-Jan-X1     10.6484
28-Jan-X1     10.6444
31-Jan-X1     10.6311
5-Feb-X1      10.6255
7-Feb-X1      10.6201
28-Feb-X1    10.6150

Market Rate
America Movil ADR
January 31: $54.50
February 28: $53.00
America Movil Local
January 31: MXN 58.00
February 28: MXN 55.00

Objective Questions

1. An instrument representing ownership interest in securities of a foreign issuer is referred to as
a. An ownership certificate.
b. A depositary receipt.
c. An ownership receipt.
d. None of the above.

2. Depositary receipts that are traded in an international market other than the United States are referred to as
a. Global depositary receipts
b. International depositary receipts.
c. Open market depositary receipts.
d. None of the above.

3. Issuance of DRs is based on the increase of demand in the
a. Local market.
b. International market.
c. Existing shareholders.
d. All of the above.

4. Each DR is backed by a specific number of an issuer’s local shares. This is referred to as the
a. DR ratio.
b. Issuer’s holding ratio.
c. Market holding ratio.
d. None of the above.

5. Which of the following does not constitute a benefit of DRs for the issuer?
a. Offer a new avenue for raising equity capital.
b. Broaden and diversify a company’s investor base.
c. Enhance a company’s visibility and status.
d. None of the above.

6. Which of the following does not constitute a benefit of DRs for investors?
a. Facilitate diversification into securities of foreign issuers.
b. Eliminate unfamiliar custody safekeeping arrangements.
c. Broaden and diversify the investment base.
d. None of the above.

7. ADRs that do not qualify or are not intended to be listed on stock exchanges are referred to as
a. Level 1 ADRs.
b. Level 2 ADRs.
c. Level 3 ADRs.
d. None of the above.

8. ADRs listed on stock exchanges are referred to as
a. Level 1 ADRs.
b. Level 2 ADRs.
c. Level 3 ADRs.
d. None of the above.

9. Which of the following is not an advantage of ADRs?
a. Cost-effectiveness.
b. Diversification of investment.
c, Reduction in administration cost.
d. None of the above.

10. Which of the following is not associated with the risk involved in ADRs?
a. Political risk.
b. Exchange rate risk.
c. Inflationary risk.
d. None of the above.

11. Level 1 is the most basic type of ADR where the foreign company
a. Wishes its ADR to be listed on the U.S. exchanges alone.
b. Does not wish its ADR to be listed on an exchange.
c. Does not wish its ADR to be listed on an U.S. exchange.
d. Wishes its ADR to be listed on any exchange around the world.
e. Wishes its ADR to be listed on any exchange other than U.S. exchanges.

12. Regulation S shares cannot be held or traded by any ______________, as defined by SEC Regulation S rules.
a. Non-U.S. person.
b. U.S. person.
c. European person.
d. U.S. investment firm.
e. Non-U.S. investment firm.

13. In ADR trading, when the investor places the buy order and when the broker executes the same, it becomes a binding contract between the investor and the
a. Foreign company.
b. Broker.
c. Securities Exchange Commission.
d. Stock exchange.
e. All the above.

14. The process of valuation of ADRs is known as portfolio valuation, when the market rate at the end of the period is determined from the
a. Primary stock exchange where the shares are traded.
b. Secondary market.
c. Prime broker.
d. Broker.
e. Credit rating companies.

• A depositary receipt (DR) represents an ownership interest in securities of a foreign issuer typically trading outside its home market. ADR is a tradable instrument, and the depositary receipts that are trading in the United States are known as American depositary receipts, or ADRs.
• Depositary receipts that are traded in an international market outside the United States are known as global depositary receipts, or GDRs. Most depositary receipts are quoted and traded in US$ terms. There are some DRs that are traded in euros and pounds sterling.
• Typically a bank issues depositary receipts and also functions as a depository and issuing agent for the same.
• The depositary receipt is issued against the deposit of domestic ordinary shares in the bank’s custody account in the home market.
• These shares continue to remain on deposit with the bank’s custodian until the depositary receipts are cancelled.
• When the depositary receipt is returned to the bank that acts as the depository for cancellation, the depositary bank instructs its custodian to deliver the underlying local share as per the instructions received from the party delivering the depositary receipt.
• Each depositary receipt is backed by a specified number of the issuer’s local shares, known as the depositary receipt ratio. The ratio is manipulated in such a way that the price of each DR falls in a competitive price range that is considered attractive to the issuer’s international peer group. The ratio of depositary receipt to underlying shares can be in whole numbers or fractions, depending upon the local share price.
• There are several benefits of DRs to the issuers as well as the investors.
• An American depositary receipt (ADR) is a stock that trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American markets just like regular stocks. They were first introduced to the financial markets in 1927.
• The sponsor bank purchases a bulk lot of shares from a foreign company and then bundles the shares into groups for the purpose of reissuing the same in any of the American stock exchanges. The issuing company is required to provide detailed financial information to the sponsor bank.
• Global depositary receipts are depositary receipts in Europe or other non-U.S. markets pursuant to Regulation S promulgated under the U.S. Securities Act of 1933. GDRs are listed on European stock exchanges such as London or Luxembourg.
• A company can choose to combine its GDR offering with an ADR offering into the U.S. markets. Then the ADRs may be publicly listed on a U.S. exchange and offered to retail investors, or may be privately placed with qualified institutional buyers pursuant to Rule 144A.
• There are basically three levels of ADRs that are available, each having its own merits and disadvantages. The issuing company will choose the level that fits best considering the other requirements.
• Analyzing foreign companies involves further scrutiny than merely looking at the fundamentals. In fact there are innumerable risk factors that determine the value of the depositary receipts in addition to the performance of the company. Investors should be aware of those risks.
• Restricted programs are those that are meant to be traded by only certain individuals. In the United States, the Securities Exchange Commission allows these types of issuance of shares as per Rule 144-A and Regulation S.