Securities are financial instruments that act as a way to raise money for the issuer and an investment for the buyer of the security. It is basically something of value that can be traded between parties. They can represent ownership, right to ownership, or loaner ship for the holder of the security.
Table of Contents
- 1 What Are Securities In Finance?
- 2 Types Of Securities
- 3 Securities Market Definition
- 4 Types Of The Securities Market
- 5 Conclusion
What Are Securities In Finance?
Securities are assets or materials that have monetary significance and can be exchanged for similar assets in the market. Securities are fungible, meaning that they can be traded with assets of the same type. This simplifies the trading process as well. For example, a gallon of petrol is considered fungible security as it can be exchanged for another gallon of gas as they are both considered the same. On the other hand, a pair of earrings are not fungible securities as they differ by the make and the brand. Security can represent an investment or a right to ownership. They are regulated in the United States by the Securities And Exchange Commission (SEC) to prevent fraudulent and harmful practices. There are three main types of securities – debt securities, equity securities, and derivatives.
Types Of Securities
Securities are classified as either debt security, equity security, or derivatives.
A debt security is a security that represents money that the seller of the security borrows from the buyer of the security. The seller has to repay this money back to the buyer over a period of time, with interest.
Debt securities are normally issued to generate funds for a company. Initially, when a company is starting out, it will borrow money from the bank. Banks will lend the money up to a certain amount, as they can only take so much risk with the new company. Once the company has received as much loan as is available by the bank, they issue ‘bonds’ in the capital market. When you buy a bond, you basically lend your money to the company. The bonds are issued for a fixed term. In exchange for the bond, the company pays periodic payments to you with interest. In this way, the company is borrowing money from the public and returning it as they make profits. These periodic payments are known as coupon payments and are usually given out semi-annually.
Examples of debt securities include government-issued bonds, corporate bonds, certificates of deposit, and collateralized securities like CDOs and CMOs.
Equity represents ownership. When a company wants to expand its business, it might sell shares of the company to the public. The shares are sold as either common stock or preferred stock. When an investor buys a stock, they gain a share in the ownership of the company, which entitles the owner to the profits, or the losses of the company. If the company makes a profit, it will either pay it to the stockholder quarterly as dividends or use it to further grow the business. In the latter scenario, the stockholder will see his or her shares rise in value which can be sold again for capital gains.
Equity securities give some amount of ownership to the equity holder in the form of voting rights. All ownership is proportionate to the stocks you own in the company. If the company were to go bankrupt, the equity holders get residual interest payments after all the debt has been paid off. They may receive this payment as additional bonds or equities instead of cash, known as payment-in-kind.
Equities also carry higher rewards as they are tied to the company’s fate and hence are at a higher risk of incurring a loss. The value of equity increases and decreases according to the company’s profits.
The third type of security is known as derivatives. A derivative security is a security whose price depends upon or is derived from an underlying asset, such as a stock, bond, commodity, currency, interest rate, etc. The derivative does not give you ownership outright, but you get the right to trade other financial securities at pre-decided terms. The value of the derivative is dependent upon the value of the underlying asset. The right to trade other financial assets using the derivative is governed by the maturity date, price, and interest all determined at the time of the contract. Derivatives cost less than the actual asset but give you control over them for a fraction of the actual price.
Securities Market Definition
The securities market is the place where securities are traded. Financial assets are redistributed among the participants of the market. The geographical and political conditions of the country or region play a huge part in the health of the market and the decisions of key players can cause the market to rise and fall accordingly. The securities market is also known as the capital market as it is used to generate funds and capital for running companies’ operations and expansion.
Types Of The Securities Market
The securities market can be categorized according to a number of different factors. The securities trade is regulated by the US Securities And Exchange Commission (SEC). Derivate securities are also regulated by self-regulatory bodies like the National Association Of Securities Dealers (NASD), the Financial Industry Regulatory Authority (FINRA), and the National Futures Association (NFA). The types of security markets are listed below:
The primary market is the part of the capital market where companies or government entities sell their shares to the public for the first time. These shares are offered through an initial public offering (IPO). The primary market allows the company or organization to raise funds to further aid its operations. The securities can be sold as debt-based securities like a bond, or equity-based security, like a stock. Investors pay less on the primary market than on the secondary market.
After the initial selling of the securities in the primary market, they are sold in the secondary market. Companies and investors trade their securities in the secondary market. An example of a secondary market is the New York Stock Exchange (NYSE) and the National Association Of Securities Dealers Automated Quotations (NASDAQ) exchange. Besides stocks, which are the most common and popular securities sold on the market, investment banks, and corporate and individual organizations and investors also buy and sell mutual funds and bonds on the secondary market. Unlike the primary market, where securities are sold by corporations, companies, and organizations as well as government entities, both investors and corporations trade on the secondary market.
The stock market is a collection of security exchanges where the trade of publicly held shares takes place. This includes buying, selling, and issuance of previously held stocks and bonds. There can be a number of stock exchanges and venues within a country or region. Though it is normally understood as dealing with equity securities like stocks, a stock exchange can also deal in bonds, commodities, and currencies. A stock market is regulated and provides investors to trade in a zero to a low-risk setting. The stock market reflects the economic standing of the country. The stock market works both as a primary and as a secondary market.
Over The Counter Market
An over the counter or OTC market is a decentralized and unregulated market where the trade of commodities, stock, currencies, bonds, and other financial instruments takes place without a central exchange or broker. The exchange takes place between the two parties directly and is conducted electronically. OTC markets are also less transparent as compared to stock exchanges.
Government Securities Market
The government securities market is at the heart of the financial markets in most nations. It is mostly concerned with dealing with the debt security instruments issued by the government like promissory notes, Treasury notes, and bonds. These act as financial instruments to raise money for the government, its operations, and to reduce the fiscal deficit. The government securities market also sets the benchmark for the liquidity of other assets.
Corporate Securities Market
All the securities not issued by the government are said to be issued by corporations and sold in the corporate securities market. These include both equity and debt securities.
Securities are ways of raising money, making long or short-term investments, or getting ownership or right to ownership in an organization or corporation. They can be sold unregulated in over the counter markets or in a regulated setting like stock and bond exchanges. You can use a broker to purchase them or you can buy them online yourself as well.