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International Depository Receipts - Essay Example

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The paper "International Depository Receipts" highlights that nowadays euro bonds have a maximum maturity period of 10 years. The euro bonds may be fixed or floating-rate bonds. Eurobonds are suitable sources of finance for operations, which require large capital sums of money for long period…
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International Depository Receipts
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Extract of sample "International Depository Receipts"

One of the widely used equity linked instruments for raising resources the international capital markets is through international Depository Receipts(DRs). Equity instruments available in the international markets are Global/American depository receipts, and Euro/Foreign currency convertible bond. Depository Receipts (DRs) are negotiable certificates that represents a foreign company's publicly traded equity. DRs are created when a foreign company's shares are purchased abroad and delivered to a depository's local custodian bank, usually a major money-center commercial bank such as Citibank or The Bank of New York, which are then placed in a special trust. The depository bank then issues the DR, which may represent a multiple or a fraction of the deposited share. Owners of DRs have a legal claim on the cash flows of the deposited shares. The depository bank receives the dividends, which are then paid to the holder of the DR less a small handling fee. DRs offer a number of benefits to investors seeking to diversify internationally. DRs greatly facilitate trading in foreign securities by reducing the risk of fraud. While foreign companies shares typically are written in the language of the issuer, DRs are usually issued in the language of the issuing agent. DRs are legal obligations of the issuing agent and not of the firm that issued the stock. Thus, the risk of falling prey of bogus certificates is eliminated. As such, DRs overcome many of the obstacles that mutual funds, pension funds, and other financial institutions have in investing and holding securities outside the homeland. (Geiders 1997, cited in Webster, 1998, p. 2). DRs are also convenient. Securities do not have to be delivered through international mail, prices are quoted in pounds or U.S. dollars, and pay dividends or interest in the home currency. In fact, the prices of a number of foreign stocks routinely are reported in the financial press. Importantly, global custodian safekeeping charges associated with purchasing foreign securities are eliminated, which could save the investor as much as 40 basis points annually. (Webster, 1998) An important function of DRs is that they enable foreign firms to raise capital in the most lucrative markets for investment capital such as Great Britain and United States. Listing shares directly on UK or U.S. stock exchanges, however, is problematic, Disclosure requirements are among the strictest in the world. Foreign firms also face significant costs producing UK or U.S.-style financial statements. DRs provide foreign firms with a way around these listing problems. While the potential benefits of direct foreign investment are connected to overseas diversification the potential disadvantages to investing in DRs also are communicated by overseas diversification risks: fluctuating currency values, lower liquidity, and foreign tax liability. Fluctuating currency values. An investor does not have to exchange currency to purchase DRs, but DR prices are still influenced by fluctuating currency values. Since the pricing of DRs reflects the UK pounds value of a foreign security currency movements will work to an investor's advantage when the foreign country's currency drops in value in relation to the UK currency. But the opposite also is true. The value of DRs will drop when the foreign currency increases in value against the UK pound of sterlings. Overall, DRs still tend to track with the performance of their corresponding foreign securities. Lower liquidity. Most DRs are not as actively traded as foreign shares that are traded directly As a result, DRs may not be as easy to liquidate. Brokers that specialize in trading DRs, however, can liquidate them by instructing the foreign custodian to sell the underlying securities. Foreign tax liability. Although DRs pay dividends in pounds, these payments represent conversions of foreign dividends paid to a custodian on the underlying securities. As a result, DR holders must pay foreign taxes on these dividends. Although many DRs are considered highly liquid financial assets, many depository banks argue that directly listing shares on major exchanges, such as the London or New York Stock Exchange, carries with it benefits that outweigh the costs of complying strict disclosure reporting requirements, including greater investor interest, and a broader and more diversified investor base, which implies increased market efficiency and liquidity. In general, GDR is more benefitial to 'start up' foreign companies unaccustomed to the complicated and cost incurring reporting rules and not wholly emracing GAAP accounting standards. Further, DRs are unique mean of tapping international markets and diversifying its investor base. It can also be expidient way to refinance existing at competitive cost (in this regard, start up companies should go ahead with should go ahead with the GDR issue since there are more benefits attached with the GDR as compared to American Depository Receipts (ADRs). The issue of GDR should be done in the European market as the regulations in the European market are less stringent and cost involved is less as compared to other markets of the world. The best way is to list GDR issue in the Luxembourg stock exchange, which is one of 'the less stringent markets in terms of regulations. Moreover, the issuance of GDR/ADR by a company adds to its profile and it is widely known in the investment markets overseas. However, in contrast with direct shares listing saleability/subscription to the GDRs issue may be a problem. That is one of the most important factors which a company needs to take into consideration before raising a issue. In order to ensure subscription to the issues like GDR, PFC should conduct comprehensive road shows across the major financial markets of the world to gage the investor's response towards the issue and the price they would get. Foreign Currency Convertible Bonds (FCCBs) are instruments used by the overseas corporate sector to raise funds in the international market. For example, as defined by the 'Issue of FCCB and Ordinary Shares (through depository receipt mechanism) Scheme 1993' of India - FCCBs are bonds issued in accordance with the scheme and subscribed by a non resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole or in part, on the basis of any equity related warrants attached to debt instruments. (Kumar & Krithivasan, 2005) Because of this facility the FCCB's carry a lower rate of interest than any other similar non-convertible debt instrument (ordinary binds). It has a fixed interest or coupon rate and is convertible into certain number of shares at a pre-determined price. FCCBs are also listed and traded on one or more stock exchanges abroad. Till conversion, the company has to pay interest on FCCBs in dollars or some other foreign currency and if the redemption option is not exercised the bond has to be redeemed .in foreign currency. The bonds are generally unsecured. FCCBs have a fixed rate of interest, which is lower than coupons on straight bonds of comparable terms. FCCBs can be usefull for financing of large projects depending upon their suitability and cost effectiveness. [Ordinary] International bonds are those bonds, which are initially sold outside the country of borrower. These bonds are not being issued in only one national state, in contrast with foreign bonds such as Bulldog bonds or Yankee bonds. Euro bond refers to the bonds issued and sold outside the home country of the currency of issue. For example, a dollar bond issued in Europe is called euro dollar bond. Euro bonds are simultaneously sold in many countries other than the country of currency in which the issue is denominated. These bonds are issued in international market and denominated in hard currency i.e. dollar, yen, pound, euro. Euro bonds in particular are bearer securities, the names of the bearer are not registered anywhere. Euro bonds generally unsecured debt securities maturing at least a year after launch. Euro bonds are long-term loans usually having a maturity period between 5 years to 30 years. Nowadays euro bonds have a maximum maturity period of 10 years. The euro bonds may be fixed or floating rate bonds. In general, eurobonds are suitable sources of finance for operations, which require large capital sums of money for long period. Bibliography: Kumar A. & Krithivasan N., A study of resource mobilisation from international markets for PFCL. myicwai.com/knowledgebank/fm01.pdf, August 2005 Webster Thomas J., American depository receipts, listing, and market efficiency: three case studies, Mid-Atlantic Journal of Business, Dec 1, 1998 v34 i3 p273(2) Kistner William G., ADRs: an alternative to direct foreign stock ownership. (American depository receipts), Healthcare Financial Management, Oct 1997 v51 n10 p86(1) Depositary Receipts: Guide to listing, London Stock Exchange, 2003. Read More
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