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Currency Exposure in Switching Between a UK Share and Its USD ADR

Article Quant Q&A · Author: cyrilmadrid
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Summary

The document describes an investor’s attempt to preserve exposure to a UK-listed share by replacing the position with its US dollar ADR. The investor understood each ADR to represent five UK shares and expected to be able to switch back without changing the underlying exposure. On simulating a later conversion, the investor found a larger loss than on the UK listing and questioned whether the exchange rate should have offset the currency effect.

An answer reports a historical daily profit-and-loss analysis and says the strategy’s returns were perfectly correlated with GBP/USD, indicating currency exposure despite the stated share ratio. The exchange does not provide the chart, detailed calculations, or a full explanation of the mechanism, so it establishes the reported association without resolving why the exposure arose. It highlights that a fixed ADR-to-share ratio alone does not settle how currency movements affect measured returns across listings.

Key ideas

  • The investor compares a UK share position with a USD-denominated ADR representing five shares.
  • The expected equivalence of the two positions did not match the simulated conversion outcome.
  • The reported daily P&L analysis found perfect correlation with GBP/USD.
  • The exchange identifies currency exposure but leaves its cause unexplained.

Tags

EquitiesForexMulti-asset
Full text
# Relationship between ADR in USD and original stock in GBP - Drift in price


# Relationship between ADR in USD and original stock in GBP - Drift in price












For tax reasons, I switched a position I had in the HSBC London GBP listing into the USD ADR. The ADR represents 5 shares of the GBP listing. My understanding was that since at all times 1 ADR = 5 UK stock, when holding the ADR, your underlying currency risk is still GBP which is what I wanted. So I sold my UK position to by 1/5 in the ADR, hoping that I could revert the position at some stage in the future at no cost since at all times I retained the same exposure. For some reason I don't understand, 1 year down the road, if I simulate a converstion of my position back in the UK stock, I love about 25 % when the original stock has lost only 9 %. As if had been exposed to USD/GBP risk. I understand that the price of the ADR is a function of the price of the UK stock and the UK/USD exchange rate, but if the ADR drops in price due to UK/USD, I should be able to compensate that as I will need less USD to buy back the GBP, so this factor should be offset. Can anyone understand where is the problem ? For me if at all times 1 ADR in USD = 5 UK stock, I could at all times switch from one to the other retaining the same exposure, but in practice does not seem to be the case !

## Answer by cyrilmadrid (score 1)

https://quant.stackexchange.com/a/17606

I went through historical data, and computed the daily P&L of the strategy, and correlation with GBPUSD is perfect, so the strategy is indeed affected by currency risk, even if at all times, 5 UK stock = 1 ADR

see graph

Now I still need to understand why, because my expectation was to remain at all time with a position equivalent to the one I had with the UK stock...

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.