Problem:
Nealtus' training program includes various "training rotations" where executive trainees spend some time in various departments to receive training that is more specific and gain additional experience with the international market.
This week, you have been assigned to Nealtus' trading department to gain additional knowledge about various financing and investment tools in international trade. One of the characteristics of international market is that stocks and bonds cannot simply be traded, but a convenient way to invest is through using American Depository Receipts (ADRs). Nealtus' trading department invests some of the company's excess cash in ADRs and foreign-denominated debt securities.
As part of your training, you are presented with the following two assignments:
1) Describe what an ADR is and help John Shadmond, one of Nealtus' investment managers, with the following calculation:
In the London market, JEC Inc's stock closed at £0.875 per share on Thursday, April 1, 2005. JEC trades as an ADR in the OTC market in the United States. Five underlying JEC shares are packaged into one ADR. On April 10, 2005, the British pound sterling to the U.S. spot exchange rate was £0.6366/$1.00. Determine the no-arbitrage U.S. price of one ADR.
2) John Shadmond is also interested in a 10-year Floating-Rate Note (FRN) with coupons referenced to a 6-month London Interbank Offered Rate (LIBOR). The note pays interest on a quarterly basis. Assume that the current 6-month LIBOR is 4%. If the risk premium above LIBOR that the issuer must pay is 1/4 percent, calculate the next period's coupon rate on a £1,000 face value FRN.
Note: £ = British pound symbol