What are “Securities”?
“Securities” is most commonly thought of as stocks and shares but it refers to any negotiable financial instrument that holds some type of tangible monetary value. It covers a range of assets which are essentially all tradeable. Securities can represent an ownership position in a publicly-traded corporation via stock; a creditor relationship with a governmental body or a corporation represented by owning that entity’s bond; or rights to ownership as represented by an option.
Key Learning Points
- Securities are tangible and tradable financial instruments
- They can be used to raise capital in public and private markets
- There are primarily three types of securities: equity – which provides ownership rights to holders; debt – essentially loans repaid with periodic payments; and hybrids – which combine aspects of debt and equity
- Publicly traded securities are listed on stock exchanges, where issuers can seek listings and attract investors
- Generally, securities represent an investment and a means by which municipalities, companies, and other commercial enterprises can raise new capital
Types of Security
Here is an overview of the different three broad types of securities:
A debt security represents borrowed money that must be repaid, with terms that stipulate the size (of the bond), interest rate, and maturity or renewal date. Debt securities are typically tradable. They generally entitle their holder to the regular payment of interest and repayment of principal, along with any other stipulated contractual rights. Debt instruments are typically issued for a fixed term, at the end of which they can be redeemed by the issuer.
Debt securities can be secured (backed by collateral) or unsecured, and, if unsecured, may be contractually prioritized over other unsecured, subordinated debt in the case of a bankruptcy. Debt securities include government and corporate bonds, certificates of deposit (CDs) and collateralized securities. The fundamental attractiveness of debt securities is that they can offer a higher return than simply holding cash or savings and the returns can vary depending on the investor’s risk appetite.
Overview of Secured Debt securities (backed by collateral):
An equity security represents an ownership interest in an entity (a company, partnership, or trust), realized in the form of shares of capital stock. This ownership is proportional according to the number of shares owned and can include both common and preferred stock.
Holders of equity securities are typically not entitled to regular payments such as dividends but they are able to profit from capital gains when they sell the securities (assuming they’ve increased in value). Equity security holders are in essence ‘owners’ of the underlying business or asset so can gain from any improvement in the business performance and share price. However, in the event of a downturn in the business, the equity holders may see the value reduced, even to zero, and have a lower-ranked claim on the underlying assets than debt security holders.
Hybrid Securities, as the name suggests, combine some of the characteristics of both debt and equity securities. Hybrid securities include equity warrants, convertible bonds and preference shares. Equity warrants are options that allow an investor to purchase stock at a set price (and specified time frame). Convertible bonds are bonds that can be converted into shares of common stock in the issuing company. Preference shares are company stocks whose payments of interest, dividends, or other returns of capital can be prioritized over those of other stockholders.
In the example below, we can see how all the securities on a company’s balance sheet can be classified into debt, equity and hybrid securities.