Portfolio Management – Additional Notes

AMERICAN DEPOSITORY RECEIPTS (ADR) & GLOBAL DEPOSITORY RECEIPTS (GDR)

Depository Receipts :
Depository Receipts are a type of negotiable (transferable) financial security, representing a
security, usually in the form of equity, issued by a foreign publicly-listed company. However, DRs
are traded on a local stock exchange though the foreign public listed company is not traded on
the local exchange.

Thus, the DRs are physical certificates, which allow investors to hold shares in equity of other
countries. . This type of instruments first started in USA in late 1920s and are commonly known
as American depository receipt (ADR). Later on these have become popular in other parts of the
world also in the form of Global Depository Receipts (GDRs). Some other common type of DRs
are European DRs and International DRs.

In nut shell we can say ADRs are typically traded on a US national stock exchange, such as the
New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly
listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are
usually denominated in US dollars, but these can also be denominated in Euros.

How do Depository Receipts Created?

When a foreign company wants to list its securities on another country’s stock exchange, it can
do so through Depository Receipts (DR) mode. . To allow creation of DRs, the shares of the
foreign company, which the DRs represent, are first of all delivered and deposited with the
custodian bank of the depository through which they intend to create the DR. On receipt of the
delivery of shares, the custodial bank creates DRs and issues the same to investors in the country
where the DRs are intended to be listed. These DRs are then listed and traded in the local stock
exchanges of that country.

How do Depository Receipts Created?

When a foreign company wants to list its securities on another country’s stock exchange, it can
do so through Depository Receipts (DR) mode. . To allow creation of DRs, the shares of the
foreign company, which the DRs represent, are first of all delivered and deposited with the
custodian bank of the depository through which they intend to create the DR. On receipt of the
delivery of shares, the custodial bank creates DRs and issues the same to investors in the country
where the DRs are intended to be listed. These DRs are then listed and traded in the local stock
exchanges of that country.

What are ADRs :

Portfolio Management – Additional Notes

American Depository Receipts popularly known as ADRs were introduced in the American
market in 1927. ADR is a security issued by a company outside the U.S. which physically
remains in the country of issue, usually in the custody of a bank, but is traded on U.S. stock
exchanges. In other words, ADR is a stock that trades in the United States but represents a
specified number of shares in a foreign corporation.

Thus, we can say ADRs are one or more units of a foreign security traded in American
market. They are traded just like regular stocks of other corporate but are issued / sponsored
in the U.S. by a bank or brokerage.

ADRs were introduced with a view to simplify the physical handling and legal technicalities
governing foreign securities as a result of the complexities involved in buying shares in foreign
countries. Trading in foreign securities is prone to number of difficulties like different prices
and in different currency values, which keep in changing almost on daily basis. In view of such
problems, U.S. banks found a simple methodology wherein they purchase a bulk lot of shares
from foreign company and then bundle these shares into groups, and reissue them and get
these quoted on American stock markets.

For the American public ADRs simplify investing. So when Americans purchase Infy (the Infosys
Technologies ADR) stocks listed on Nasdaq, they do so directly in dollars, without converting
them from rupees. Such companies are required to declare financial results according to a
standard accounting principle, thus, making their earnings more transparent. An American
investor holding an ADR does not have voting rights in the company.

The above indicates that ADRs are issued to offer investment routes that avoid the expensive
and cumbersome laws that apply sometimes to non-citizens buying shares on local
exchanges. ADRs are listed on the NYSE, AMEX, or NASDAQ.

Global Depository Receipt (GDR): These are similar to the ADR but are usually listed on
exchanges outside the U.S., such as Luxembourg or London. Dividends are usually paid in U.S.
dollars. The first GDR was issued in 1990.

ADVANTAGES OF ADRs:

There are many advantages of ADRs. For individuals, ADRs are an easy and cost effective way
to buy shares of a foreign company. The individuals are able to save considerable money and
energy by trading in ADRs, as it reduces administrative costs and avoids foreign taxes on each
transaction. Foreign entities prefer ADRs, because they get more U.S. exposure and it allows
them to tap the American equity markets.
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The shares represented by ADRs are without voting rights. However, any foreigner can
purchase these securities whereas shares in India can be purchased on Indian Stock Exchanges
only by NRIs or PIOs or FIIs. The purchaser has a theoretical right to exchange the receipt
without voting rights for the shares with voting rights (RBI permission required) but in practice,
no one appears to be interested in exercising this right.

Some Major ADRs issued by Indian Companies : Among the Indian ADRs listed on the US markets,
are Infy (the Infosys Technologies ADR), WIT (the Wipro ADR), Rdy(the Dr Reddy’s Lab ADR), and
Say (the Satyam Computer ADS)

What are Indian Depository Receipts (IDR) :

Recently SEBI has issued guidelines for foreign companies who wish to raise capital in India by
issuing Indian Depository Receipts. Thus, IDRs will be transferable securities to be listed on
Indian stock exchanges in the form of depository receipts. Such IDRs will be created by a
Domestic Depositories in India against the underlying equity shares of the issuing company which
is incorporated outside India.

Though IDRs will be freely priced., yet in the prospectus the issue price has to be justified. Each
IDR will represent a certain number of shares of the foreign company. The shares will not be
listed in India , but have to be listed in the home country.
The IDRs will allow the Indian investors to tap the opportunities in stocks of foreign companies
and that too without the risk of investing directly which may not be too friendly. Thus, now
Indian investors will have easy access to international capital market.
Normally, the DR are allowed to be exchanged for the underlying shares held by the custodian
and sold in the home country and vice-versa. However, in the case of IDRs, automatic fungibility
is not permitted.

SEBI has issued guidelines for issuance of IDRs in April, 2006, Some of the major norms for
issuance of IDRs are as follows. SEBI has set Rs 50 crore as the lower limit for the IDRs to be
issued by the Indian companies. Moreover, the minimum investment required in the IDR issue
by the investors has been fixed at Rs two lakh. Non-Resident Indians and Foreign Institutional
Investors (FIIs) have not been allowed to purchase or possess IDRs without special permission
from the Reserve Bank of India (RBI). Also, the IDR issuing company should have good track record
with respect to securities market regulations and companies not meeting the criteria will not be
allowed to raise funds from the domestic market If the IDR issuer fails to receive minimum 90
per cent subscription on the date of closure of the issue, or the subscription level later falls below
90 per cent due to cheques not being honoured or withdrawal of applications, the company has
to refund the entire subscription amount received, SEBI said. Also, in case of delay beyond eight
days after the company becomes liable to pay the amount, the company shall pay interest at the
rate of 15 per cent per annum for the period of delay.
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What is ADR and GDR?

Companies are permitted to raise foreign currency resources through two main sources: a) issue
of foreign currency convertible bonds more commonly known as ‘Euro’ issues and b) issue of
ordinary shares through depository receipts namely ‘Global Depository Receipts
(GDRs)/American Depository Receipts (ADRs)’ to foreign investors i.e. to the institutional
investors or individual investors.

An American Depositary Receipt (“ADR”) is a physical certificate evidencing ownership of

American Depositary Shares (“ADSs”). The term is often used to refer to the ADSs themselves.

What is an ADS?
An American Depositary Share (“ADS”) is a U.S. dollar denominated form of equity ownership in
a non-U.S. company. It represents the foreign shares of the company held on deposit by a
custodian bank in the company ‘s home country and carries the corporate and economic rights
of the foreign shares, subject to the terms specified on the ADR certificate.
One or several ADSs can be represented by a physical ADR certificate. The terms ADR and ADS
are often used interchangeably. ADSs provide U.S. investors with a convenient way to invest in
overseas securities and to trade non-U.S. securities in the U.S. ADSs are issued by a depository
bank, such as JPMorgan Chase Bank. They are traded in the same manner as shares in U.S.
companies, on the New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX) or
quoted on NASDAQ and the over-the-counter (OTC) market.
Although ADSs are U.S. dollar denominated securities and pay dividends in U.S. dollars, they do
not eliminate the currency risk associated with an investment in a non-U.S. company.
What is meant by Global Depository Receipts?
Global Depository Receipts (GDRs) may be defined as a global finance vehicle that allows an issuer
to raise capital simultaneously in two or more markets through a global offering. GDRs may be
used in public or private markets inside or outside US. GDR, a negotiable certificate usually
represents company’s traded equity/debt. The underlying shares correspond to the GDRs in a
fixed ratio say 1 GDR=10 shares.

FCCB
Portfolio Management – Additional Notes

Foreign currency convertible bonds (FCCBs) are a special category Bond Finance. FCCBs are
issued in currencies different from the issuing company's domestic currency. Corporates issue
FCCBs to raise money in foreign currencies. These bonds retain all features of a convertible bond,
making them very attractive to both the investors and the issuers.
These bonds assume great importance for MNC and in the current business scenario
of Globalisation, where companies are constantly dealing in foreign currencies.
FCCBs are quasi-debt instruments and tradable on the Stock Exchange. Investors are Hedge-fund
arbitrators or foreign nationals.
FCCBs appear on the liabilities side of the issuing company's Balance Sheet
Under IFRS provisions, a company must mark to market the amount of its outstanding bonds.
FCCB are issued by a company which can be redeemed either at maturity or at a price assured by
the issuer. In case the company fails to reach the assured price, bond issuer is to get it redeemed.
The price and the yield on the bond moves on the opposite direction. The higher the yield, lower
is the price.
Foreign currency convertible bonds are equity linked debt securities that are to be converted into
equity or depository receipts after a specified period. thus a holder of FCCB has the option of
either converting it into equity share at a predetermined price or exchange rate, or retaining the
bonds.

Some companies, banks, governments, and other sovereign entities may decide to issue bonds
in foreign currencies as it may appear to be more stable and predictable than their domestic
currency. Issuing bonds denominated in foreign currencies also gives issuers the ability to access
investment capital available in foreign markets. The proceeds from the issuance of these bonds
can be used by companies to break into foreign markets, or can be converted into the issuing
company's local currency to be used on existing operations through the use of foreign exchange
swap hedges. Foreign issuer bonds can also be used to hedge foreign exchange rate risk. Some
foreign issuer bonds are called by their nicknames, such as the "samurai bond". These can be
issued by foreign issuers looking to diversify their investor base away from domestic markets.
These bond issues are generally governed by the law of the market of issuance, e.g., a samurai
bond, issued by an investor based in Europe, will be governed by Japanese law. Not all of the
following bonds are restricted for purchase by investors in the market of issuance.

 Eurodollar bond, a U.S. dollar-denominated bond issued by a non-USA Entity outside the U.S
 Yankee bond, a US dollar-denominated bond issued by a non-US entity in the US market
 Portfolio Management – Additional Notes

 Kangaroo bond, an Australian dollar-denominated bond issued by a non-Australian entity in

the Australian market
 Maple bond, a Canadian dollar-denominated bond issued by a non-Canadian entity in the
Canadian market
 Shibosai Bond, a private placement bond in Japanese market with distribution limited to
institutions and banks.
 Shogun bond, a non-yen-denominated bond issued in Japan by a non-Japanese institution or
government
 Bulldog bond, a pound sterling-denominated bond issued in London by a foreign institution
or government.

DEFINITION of 'Foreign Bond'

A bond that is issued in a domestic market by a foreign entity, in the domestic market's currency.
A foreign bond is most often issued by a foreign firm to raise capital in a domestic market that
would be most interested in purchasing the firm's debt. For foreign firms doing a large amount
of business in the domestic market, issuing foreign bonds is a common practice.

DEFINITION of 'Foreign Currency Convertible Bond - FCCB'

A type of convertible bond issued in a currency different than the issuer's domestic currency. In
other words, the money being raised by the issuing company is in the form of a foreign currency.
A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making
regular coupon and principal payments, but these bonds also give the bondholder the option to
convert the bond into stock.

Difference between a global mutual fund and an international mutual fund?

 A global mutual fund invests in assets around the world including the home country.
 An international mutual fund invests in assets around the world excluding the home country.
 An "ex [insert country name here]" mutual fund invests in a region excluding the area after the
"ex". For example, a fund that is called something like "XYZ Asian Stock Fund ex. Japan" would
have to invest at least 80% in Asian stocks excluding Japanese stocks.

Global Mutual Funds Cover a Lot of Territory

Global funds are often categorized by where they invest. Some of the most common kinds of
funds are:
Portfolio Management – Additional Notes

Global equity and fixed-income funds. Sometimes called world mutual funds, they typically have
the broadest geographic investment mandates and are usually able to invest anywhere in the
world. They may invest a larger portion of their assets in the United States and the developed
markets of Europe and Asia. Global hybrid funds invest in both equity and fixed-income securities
from around the world.
The ability to invest anywhere in the world is one big advantage global funds offer because they
have the greatest number of securities from which to choose. Investing globally, however, may
involve higher risks depending on market conditions, currency exchange rates and economic,
social and political climates of the countries where the fund invests.
International equity and fixed-income funds. Often called foreign funds, they invest outside the
United States. They typically invest in the developed markets of Europe and Asia. Depending on
their investment strategy, they may also invest in emerging or frontier markets. An international
hybrid fund invests in combinations of equity and fixed-income securities from non-U.S.
countries.
By investing outside the United States, these funds can potentially capitalize on different
economic cycles occurring in different countries at different times, thereby complementing funds
that invest primarily in the U.S. Investing abroad, however, may involve higher risks depending
on market conditions, currency exchange rates and economic, social and political climates of the
countries where the fund invests.
Regional equity funds. As the name suggests, these funds concentrate in a particular region of
the world. For example, a regional fund may focus on the stocks of Europe, Latin America or
Pacific Rim nations. Such a focus can be rewarding if the region is experiencing high growth rates,
as has been the case in Asia at various times over the last two decades.
However, the limited geographic scope of these funds may increase their volatility as negative
events in one country often spill over into neighboring countries, dragging down the region as a
whole.
Country-specific equity funds. These funds have very specific investment mandates that restrict
the majority of their investing to a single country. Typically, they focus on a country with a
significant stock market or stock market growth potential. A narrow focus, however, can
substantially increase risk.
Emerging and frontier markets funds. These funds invest principally in the less developed
markets of Africa, Latin America, Asia and Eastern Europe. Typically, these types of regions are
undergoing dramatic economic change, such as transforming from a state-run economy into a
free-market-based economy. Compared with more mature markets, investing in emerging or
frontier markets may offer the potential for sharp growth rates.
However, investments in foreign securities involve special risks including currency fluctuations,
and economic and political uncertainties. As a result, such funds can experience significant
volatility.
Portfolio Management – Additional Notes

DEFINITION of 'Global Fund'

A type of mutual fund, closed-end fund or exchange-traded fund that can invest in companies
located anywhere in the world, including the investor's own country. These funds provide more
global opportunities for diversification and act as a hedge against inflation and currency risks.

DEFINITION of 'Arbitrage Pricing Theory - APT'

An asset pricing model based on the idea that an asset's returns can be predicted using the
relationship between that same asset and many common risk factors. Created in 1976 by Stephen
Ross, this theory predicts a relationship between the returns of a portfolio and the returns of a
single asset through a linear combination of many independent macro-economic variables.

In Finance, arbitrage pricing theory (APT) is a general a theory of Asset Pricing that holds that
the Expected Returns of a financial asset can be modeled as a linear function of various macro-
economic factors or theoretical market indices, where sensitivity to changes in each factor is
represented by a factor-specific Beta Coefficient. The model-derived rate of return will then be
used to price the asset correctly - the asset price should equal the expected end of period
price Discounting at the rate implied by the model. If the price diverges, Arbitrage should bring it
back into line.
The APT was proposed by the Stephen Ross
Risky asset returns are said to follow a factor intensity structure if they can be expressed as:

where

 is a constant for asset

 is a systematic factor
 is the sensitivity of the th asset to factor , also called factor loading,
 and is the risky asset's idiosyncratic random shock with mean zero.
Idiosyncratic shocks are assumed to be uncorrelated across assets and uncorrelated with
the factors.
The APT states that if asset returns follow a factor structure then the following relation
exists between expected returns and the factor sensitivities:

where
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 is the Risk Premium of the factor,

 is the Risk free rate,
That is, the expected return of an asset j is a Linear function of the asset's
sensitivities to the n factors.
Note that there are some assumptions and requirements that have to be fulfilled
for the latter to be correct: There must be Perfect Competition in the market, and
the total number of factors may never surpass the total number of assets