Question

1.) The Korean steel company PoSCO trades in the US on the NYSE as an ADR with the symbol PKX. The price of an ordinary share on the Seoul stock exchange is Korean won (KRW) 500,000 and the price of the ADR is US$100. The current exchange rate is KRW1,250/$. You have $100,000 to invest. It takes 4 ADRs to buy 1 ordinary share. Six months from today the local currency price is KRW525,000 and the exchange rate is KRW1,000/. a.) What is your rate of return measured in dollars? b.) Suppose 3 ADRs buy 1 ordinary share. What is your return measured in dollars?

Answer 1

Answer:

a) 31.25%

b) 74.83%

Explanation:

You need to take below steps in the investment circle:

(1) You have $100,000 to invest and the price of the ADR is $100; so you can buy 1,000 ADRs = $100,000/ $100

(2)  It takes 4 ADRs to buy 1 ordinary share; so with 1,000 ADRs you can buy 250 ordinary shares = 1,000 ADRs / 4 ADRs

Six months from today, price for 1 ordinary share is KRW525,000 and the exchange rate is KRW1,000/$.

(3) If you sell 250 ordinary shares, you can get KRW131,250,000 = 250 shares x KRW525,000

(4) Then you sell KRW131,250,000 to get $131,250 = KRW131,250,000/ exchange rate KRW1,000/$

So the profit after 6 months is $31,250 = $131,250 - $100,000

The rate of return is 31.25% = $31,250/$100,000 x 100%

Suppose 3 ADRs buy 1 ordinary share, then some steps changed as below:

(1) same as above

(2) you can buy 333  ordinary shares = 1,000 ADRs / 3 ADRs

(3) If you sell 333 ordinary shares, you can get KRW174,825,000 = 333 shares x KRW525,000

(4) Then you sell KRW174,825,000 to get $174,825 = KRW174,825,000/ exchange rate KRW1,000/$

So the profit after 6 months is $74,825 = $174,825- $100,000

The rate of return is 74.83% = $74,825/$100,000  x 100%