Securities. Kinds of Securities

A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages, the term “security” is commonly used in day-to-day parlance to mean any form of financial instrument, even though the underlying legal and regulatory regime may not have such a broad definition. In some jurisdictions the term specifically excludes financial instruments other than equities and fixed income instruments. In some jurisdictions it includes some instruments that are close to equities and fixed income, e.g., equity warrants.

Securities may be represented by a certificate or, more typically, “non-certificated”, that is in electronic (dematerialized) or “book entry” only form. Certificates may be bearer, meaning they entitle the holder to rights under the security merely by holding the security, or registered, meaning they entitle the holder to rights only if he or she appears on a security register maintained by the issuer or an intermediary. They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, limited partnership units, and various other formal investment instruments that are negotiable and fungible.

In the United Kingdom, the national competent authority for financial markets regulation is the Financial Conduct Authority; the definition in its Handbook of the term “security” applies only to equities, debentures, alternative debentures, government and public securities, warrants, certificates representing certain securities, units, stakeholder pension schemes, personal pension schemes, rights to or interests in investments, and anything that may be admitted to the Official List.

A security is a tradable financial asset of any kind. Securities are broadly categorized into:

• Debt securities (e.g., banknotes, bonds and debentures)
• Equity securities (e.g., common stocks)
• Derivatives (e.g., forwards, futures, options, and swaps).

The company or other entity issuing the security is called the issuer. A country’s regulatory structure determines what qualifies as a security. For example, private investment pools may have some features of securities, but they may not be registered or regulated as such if they meet various restrictions.

Securities are the traditional way that commercial enterprises raise new capital. These may be an attractive alternative to bank loans depending on their pricing and market demand for particular characteristics. Another disadvantage of bank loans as a source of financing is that the bank may seek a measure of protection against default by the borrower via extensive financial covenants. Through securities, capital is provided by investors who purchase the securities upon their initial issuance. In a similar way, a government may issue securities too when it needs to increase government debt.

Types of Securities

1. Equity securities

Equity almost always refers to stocks and a share of ownership in a company (which is possessed by the shareholder). Equity securities usually generate regular earnings for shareholders in the form of dividends. An equity security does, however, rise and fall in value in accord with the financial markets and the company’s fortunes.

2. Debt securities

Debt securities differ from equity securities in an important way; they involve borrowed money and the selling of a security. They are issued by an individual, company, or government and sold to another party for a certain amount, with a promise of repayment plus interest. They include a fixed amount (that must be repaid), a specified rate of interest, and a maturity date (the date when the total amount of the security must be paid by).

Bonds, bank notes (or promissory notes), and Treasury notes are all examples of debt securities. They all are agreements made between two parties for an amount to be borrowed and paid back with interest at a previously-established time.

3. Derivatives

Derivatives are a slightly different type of security because their value is based on an underlying asset that is then purchased and repaid, with the price, interest, and maturity date all specified at the time of the initial transaction.

The individual selling the derivative doesn’t need to own the underlying asset outright. The seller can simply pay the buyer back with enough cash to purchase the underlying asset or by offering another derivative that satisfies the debt owed on the first.

A derivative often derives its value from commodities such as gas or precious metals such as gold and silver. Currencies are another underlying asset a derivative can be structured on, as well as interest rates, Treasury notes, bonds, and stocks.

Derivatives are most often traded by hedge funds to offset risk from other investments. As mentioned above, they don’t require the seller to own the underlying asset and may only require a relatively small down payment, which makes them favorable because they are easier to trade.