Securities

Securities refer to tradable financial instruments or assets that have economic value. Companies issue these instruments to raise capital for financing their activities. Common examples include stocks, bonds, options, etc. The Securities and Exchange Commission (SEC) regulates the issue of such financial instruments in the United States.

Currently, marketable one can trade securities over the counter and through electronic media. Public companies or the government issue the financial instruments, and the investors buy them from the primary market. Further transactions occur in the secondary market, where investors assume the role of buyers and sellers, thus transferring the title of the securities.

• Securities refer to any financial instrument by a company or a government to finance certain activities.
• Earlier, these instruments were traded on the floor of the exchanges. But constant technological developments have digitized trading, and investors can buy and sell online. NASDAQ, one of the top exchanges in the world, only has an online presence.
• There are four major types of securities in finance - equity (high-risk, high-return stocks), debt (low-risk, low-return loans), hybrid (combination of equity and debt), and derivatives (financial contracts based on the value of an underlying asset).

Securities in finance form a major share of investments. The term ‘security’ refers to any instrument that serves as collateral or guarantee. Hence, an issuer of such an instrument can approach an investor to provide them with the required amount. However, the investor would look for something in return from such an exchange.

This is why equity investors receive dividends, and debenture-holders or bondholders get interest payments on their investments. However, each of these instruments' risk and return parameters are different. Further, the issuer can also affect the investments to an extent.

For example, instruments issued by reputed and established companies offer high investment returns. This increases the demand for such a company's securities, making them expensive.

Now, let's examine why the securities market has become prominent worldwide. A company usually receives capital from many sources - bank loans and credit. This constitutes debt. But there is a limit to financing a company's activities purely through debt, especially loans.

Finance experts would say that the ideal debt-equity ratio must be 2:1. Therefore, equity financing is important too. Plus, other forms of debt, like debentures, can also help to raise capital for activities like expansion into a new market, product development, or a new project.

For an investor, it is a source of income, and they get to choose the source. Investors who want assured returns can opt for fixed-income assets like debentures or preference shares. If they want high returns on their investments but are willing to face some uncertainties, they can invest in stocks.

Hence, trading, or investing, is like an exchange between two parties, where one is looking for capital and the other for income. However, this doesn't happen at random. Trading assets is one of the most organized activities, and the government regulates it.

The investor and the issuer must adhere to the regulations or risk losing. Usually, multiple government authorities have regulatory interests in the market. For instance, in the U.S., the SEC, Financial Industry Regulatory Authority (FINRA), and the Federal Reserve are some government organizations that supervise trading activities.

Marketable securities can be bought and sold through many options, depending on the asset. For example, stocks can be traded via stock exchanges, whereas bonds can be bought from the government. However, in some countries, investors can buy bonds only through brokers.

Nevertheless, let's understand the structure of the market. First, private firms have to become publicly listed to be able to raise capital from the public. This is done through an initial public offering (IPO). Then, investors can buy the assets from the company directly in the primary market.

These investors can later sell the assets in the secondary market at their market price. Further buying and selling take place in the secondary market itself. Equity shareholders receive a share of the net profits, and creditors are paid the loan interest.

Let's look at the four main categories of financial instruments sold in the securities market.

#1 - Equity securities

It refers to a stock - common or preferred, held by investors, who are referred to as equity shareholders. When a person holds equity, the ownership of a part of the company is transferred to them. So, they also enjoy voting rights in the firm. Hence, equities are generally more expensive than other types of instruments. Also, they are riskier assets. However, when the company makes a high profit, the shareholders, too, get high profits in the form of dividends. Or, if the company makes a loss, the equity shareholders are paid after all other debts and obligations are settled.

#2 - Debt securities

Debt instruments are a type of loan that carries a low risk. However, upon maturity, they deliver fixed interests. Therefore, by issuing debt instruments, the company is borrowing a loan. It can be secure or not secure. Common examples include government bonds and debentures issued by companies. Their issuance is for a specific term; one can redeem them when they mature. When a company faces heavy losses, the creditors get preference.

#3 - Hybrid securities

These are those instruments that have the characteristics of both debt and equity investments. Preference shares, convertible bonds, and equity warrants are common examples. For instance, preference shares resemble equity shares but are less riskier than the latter, i.e.; they are given preference (only after debentures). Also, they have fixed interests, typically higher than debenture interests.

#4 - Derivatives

These are other financial instruments whose value depends on an underlying asset, such as commodities, currencies, etc. The investors do not have legal possession of the assets. Examples are options, futures, forward contracts, etc.

Here are a few examples of securities.

Example #1

Jane is an experienced investor who maintains a diversified portfolio. The securities in her portfolio include an equity share of a FAANG company, six shares of a small internet company, T-bonds, and a 10-year mutual fund. She has invested a total of $525 as of now. Her financial advisor, Mark, manages her portfolio.

Example #2

Here's an example of security – single-stock ETFs. Exchange-traded funds are instruments whose value depends on multiple underlying assets or an index. They resemble mutual funds in that they are pooled investments. However, unlike mutual funds, people can trade them via exchanges.

Single-stock ETFs are a new development that functions as leveraged ETFs on a particular stock. That is, add derivatives contracts to ETFs to get single-stock ETFs. The main advantage of such an asset is to get quick high returns. However, finance experts claim that single-stock ETFs are risky and complex for around 99% of investors, especially when high volatility kicks in.

A financial instrument traded for monetary or economic value can be a security. A stock is such an instrument. Therefore, a stock is a security, but not all securities are stocks.

Financial instruments can vary in risk, returns, nature, and many other factors. But stocks are usually high-risk assets associated with higher returns. Also, not all instruments confer ownership rights to the investors. Such a feature is only associated with stocks.

This article has been a guide to Securities and its meaning. We explain its types, examples, how to trade it, and its comparison with stocks. You may also find some useful articles here -

• Debt Securities
• Investment Securities
• Hybrid Securities