ADRs baffle many.

Or so it seems by the number of responses I received from a recent

column in which I answered a question about the price differences between American Depositary Receipts and those in the home market. I described how, although theoretically there should be no difference between the two prices, a premium or discount between the two can develop for a number of reasons. The column generated a number of other questions about these investment instruments, which are not the actual shares of a foreign company but certificates deposited in a bank.

Brent Fredberg

wrote, "Great story recently on ADRs.

Taiwan Semiconductor

(TSM) - Get Report

is an interesting story given that the price discrepancy has been so large. Do these prices tend to converge over time, in which case an investor would want to make sure his potential appreciation, minus ADR premium decrease, will still be attractive? Maybe it's just if the original company allows for more ADRs or the government allows greater foreign ownership?"

Whether the prices tend to converge over time really depends on the root cause for the premium or discount. There are three basic reasons for a price divergence between ADRs and local shares: concerns about the risks involved in the local market, making the ADRs more attractive; a lack of liquidity in either market; and government restrictions on foreign ownership of a company. Of the three, the liquidity factor seems most likely to cause share prices to converge over time, because that is more of a short-term aberration. Risk might diminish in a country and make the home shares look more attractive, but that would occur over time and is difficult to predict.

In the case of Taiwan Semiconductor, where the ADRs trade at a premium to the local shares, it is unlikely that the two prices will converge because the divergence is caused by the Taiwanese government's restrictions on foreign ownership of a company, which limits the number of ADRs available. Until that situation changes, it is difficult to imagine the prices converging. Moreover, it is very difficult to get a license to buy Taiwanese stocks, and very expensive to buy them through a broker, so there is little incentive to try to buy this company on the home market.

Moving on,

Andy Roth

asks, "What's the difference between an ADR and a stock that trades with a "F" on the end of it like PCWKF? For example, I can only assume that PCWKF (

Pacific Century Cyberworks

(PCW)

) is a foreign security that trades on a foreign market

but

is available to purchase in U.S. currency because of its popularity. The market makers are the ones that handle the currency conversion when acquiring the certificate, right?"

Actually, the ticker for the ADRs of Hong Kong-based Pacific Century Cyberworks is PCW. (On the

Hong Kong Stock Exchange

, its code is 8.) It began listing on the

NYSE

in August. ADRs trade on both the NYSE and the

Nasdaq

as well as over the counter and there is no way to tell just by its ticker whether a stock is an ADR.

As to the second question, the bank that buys the shares and deposits them is the entity that handles the currency conversion. Trades of ADRs, which, again, are the certificates issued by the bank not the shares themselves, all occur in dollars. The U.S. investor does not have to convert his or her money into the local currency at any time.

Interestingly, questions such as these that I've received concerning ADRs all relate to the very reasons ADRs were created in the first place, which was to provide U.S. investors an opportunity to buy shares in foreign companies while limiting some of the risk involved.

The bottom line is that ADRs are convenient and present tremendous opportunities for investors. But you still have to make judgments about investing in those companies the old-fashioned way: by looking at such factors as valuation, earnings potential and quality of management.

David Kurapka's Global Portfolio column appears Mondays, Wednesdays and Fridays on TSC. In keeping with TSC's editorial policy, he does not own shares in any companies or mutual funds mentioned in this column. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send it to

David Kurapka.