FINRA Series 7Investment Information and Suitable RecommendationsMedium
A U.S. investor holds an ADR representing shares of a British company. If the British pound weakens significantly against the U.S. dollar, what is the most likely effect on the investor's dividend income when converted to dollars?
- AThe dividend is unaffected because ADR dividends are always paid in U.S. dollars
- BThe dividend is converted at a fixed exchange rate set at the time of ADR issuance
- CThe dividend increases in dollar terms because fewer pounds are needed
- DThe dividend decreases in dollar terms because each pound converts to fewer dollars
Show answer & explanationAnswer & explanation
Correct answer: D. The dividend decreases in dollar terms because each pound converts to fewer dollars
ADR dividends are declared in the foreign currency and then converted to U.S. dollars for distribution. If the foreign currency weakens relative to the dollar, each unit of foreign currency buys fewer dollars, reducing the dividend's dollar value — this is currency (exchange rate) risk inherent in ADRs.
Why the other options are wrong
- A. Incorrect — dividends are declared in the foreign currency, then converted, exposing investors to currency risk.
- B. Incorrect — there is no fixed exchange rate; conversion occurs at the current rate.
- C. Incorrect — a weaker pound means less value per pound, not more.
ADR Currency Risk
American Depositary Receipts expose U.S. investors to exchange rate risk because dividends and share values are converted from the foreign currency into U.S. dollars.
- ADRs represent shares of foreign companies traded on U.S. exchanges
- Dividends are declared in local currency, then converted to USD
- A weaker foreign currency reduces the dollar value of dividends and share price
Memory trick: Weak foreign currency, weak dollar dividend.