1.7 Asset Classes- Other Securities Flashcards
Who are the participants in the DR market?
DRs are typically created (or sponsored) by the foreign corporation (Volkswagen in the above example). They will liaise with an investment bank regarding the precise structure of the DR, such as the number or fraction of shares represented by each DR. A depository bank will then accept a certain number of underlying shares from the issuer, create the DRs to represent the shares and make these DRs available to US, and potentially other, investors, probably via local brokers.
Name the two types of Depository Receipts (DR) and how do they differ?
Depositary receipts (DRs) come in two broad forms – American depositary receipts (ADRs) and global depositary receipts (GDRs). The US is a huge pool of potential investment. Therefore, substantial non-US companies may want to attract US investors to raise funds. ADRs facilitate this process; indeed, they were created to make it easier for Americans to invest in overseas companies. GDRs are depositary receipts that are identical to ADRs, except that they are marketed to appeal to a broader base of investors, some of whom may be based outside America. Both ADRs and GDRs are negotiable certificates evidencing ownership of shares in a corporation from a country outside the US. Each DR has a particular number of underlying shares, or is represented by a fraction of an underlying share.
Explain Grey Market Trading
One characteristic of DRs that must also be considered is pre-release or grey market trading. When a DR is being created, the depository bank receives notification that, in the future, the shares will be placed on deposit. As long as it holds cash collateral, even though the shares are not yet on deposit, the depository bank can create and sell the receipt (the DR) at this time. Effectively, investors are buying a receipt that entitles them to all the benefits of a share that will, in the future, be held on deposit for them. The DR can be treated in this way for up to three months before the actual purchase of the underlying shares.
The shares underlying the DR are registered in the name of the depository bank, with the DRs themselves transferable as bearer securities. The DRs are typically quoted and traded in US dollars and are governed by the trading and settlement procedures of the market on which they are traded.
What is the role of the depository bank (DR)?
The depository bank acts as a go-between for the investor and the company. When the company pays a dividend, it is paid in the company’s domestic currency to the bank, which then converts the dividend into dollars and passes it on to the DR holders. The US investors therefore need not concern themselves with currency movements. Furthermore, when a DR holder decides to sell, the DRs will be sold on in dollars. This removal of the need for any currency transactions for the US investor is a key attraction of the DR.
DR holders are entitled to vote, just like ordinary shareholders, only the votes will be exercised via the depository bank.
What is the stamp duty for DRs trading the UK vs outside?
If the DR represents a UK company’s shares, there are tax ramifications. The UK tax authority, Her Majesty’s Revenue & Customs (HMRC) levies a tax known as stamp duty on share purchases, at 0.5% of the price paid to purchase shares.
However, because DRs may trade outside the UK, ie, in the US, no stamp duty is charged on the purchase of a DR. Instead, HMRC charges a one-off fee for stamp duty of 1.5%, when the DR is created.
How to sell DRs…
If an investor wants to sell his DRs, he can do so either by selling them to another investor as a DR, or by selling the underlying shares in the home market of the company concerned. The latter route will involve cancelling the DR by delivering the certificates to the depository bank. The depository bank will then release the appropriate number of shares in accordance with the instructions received.
What are warrants?
Traditionally, a warrant is an instrument issued by a company that allows the holder to subscribe for shares in that company at a fixed price over a fixed period. A typical warrant may have a life of several years.
Warrants are listed and traded on stock exchanges. If the holder decides to exercise, the company will issue new shares.
What are the advantages to a company, that persuade it to issue warrants?
Clearly, the sale of warrants for cash will raise money for the company, and, if the warrants are exercised, then further capital will be raised by the company. Similarly to call options, holding the warrant does not entitle the investor to receive dividends or to vote at company meetings, so the capital raised until the warrant is exercised could be considered as free.
Obviously warrants offer a highly geared investment opportunity for the investor, and they are often issued alongside other investments, rather than sold in their own right.
What are Covered Warrants?
Another type of warrant is a covered warrant. These are warrants issued by firms (usually investment banks), rather than the company whose shares the warrant enables the investor to buy. They are offered in the form of call warrants (giving the investor the right to buy), or put warrants (giving the investor the right to sell). In the UK, covered warrants are traded on the LSE.
Describe Warrant Price Behaviour…
Warrants (including covered warrants) are highly geared investments. A modest outlay can result in a large gain, but the investor can lose the value of their entire stake in the warrant. Their value is driven by the length of time for which they are valid (their maturity or period until expiry) and the value of the underlying security.
There is a relatively simple method of looking at the price of one warrant relative to other warrants – using the conversion premium. This is the price of the warrant plus the exercise price required to buy the underlying share, less the prevailing share price.
Note that if the resultant figure were a negative, the warrant would be trading at a conversion discount.
What are ADRs?
a means by which US investors can invest easily in overseas companies. They assist with:
- FX of capital amounts
- FX of dividend receipts
- Voting is carried out on behalf of ADR holder
