Before analyzing securities, it is essential for financial analysts, economists, business policymakers, and investors to know about different types of securities. Depending upon a wide variety of considerations, securities can be classified into four broad groups.
Security is a financial instrument that can be traded between parties in the open market.
There are 4 types of securities.
Holders of equity securities (e.g., shares) can benefit from capital gains by selling stocks.
How Securities are Traded?
Investors can purchase publicly traded securities on stock exchanges, such as the NASDAQ and New York Stock Exchange.
If a stock isn’t listed on one of the main stock exchanges, investors can also purchase securities directly from the issuer, which is called over-the-counter trading.
In the U.S., it’s the job of the U.S. Securities and Exchange Commission to regulate the securities market and protect investors against stock market manipulation.
After a company’s initial public offering (IPO), investors can buy and sell the securities on the secondary market.
The secondary market means that new investors can only purchase securities from current shareholders.
When current shareholders sell their securities, they’re selling to other investors, ideally for capital gain, meaning they sell their securities for more than they initially bought them for.
4 Types of Securities
There are four primary types of securities:
Equity security is a share of ownership in a company, trust, or partnership. Equity securities are usually shares of common stock, but can also be preferred stock.
When the issuer of equity security generates a profit and retains earnings, the issuer often pays out some earnings to shareholders by way of dividends.
Equity securities can increase or decrease in value depending on the performance of the company and the financial markets.
Debt securities, also called fixed-income securities, allow governments and corporations to raise money through publicly-traded loans in exchange for regular payments of interest plus the repayment of the principal loan.
With debt securities, the investor is the lender and the issuer is the borrower. An investor purchasing debt security receives interest payments from the issuer until the loan reaches its maturity date.
At that time, the issuer then repays their initial debt obligation, known as the principal balance.
Examples of common debt securities include certificates of deposit (CDs), corporate bonds, and government bonds, which include municipal bonds and treasury bonds.
Government bonds typically have a lower interest rate than corporate bonds but have high liquidity, which makes it easy for the investor to potentially resell on the secondary bond market.
Hybrid securities contain elements of both equity securities and debt securities.
One example of hybrid security is convertible bonds—corporate bonds that can be converted into shares of stock for the issuing company.
Another example is preference shares, which are stock shares in a company that entitles the shareholder to receive a fixed dividend before common stock dividends.
Preference shares may even grant shareholders voting rights in the company.
The value of derivative security depends on the value of another underlying asset (e.g., a barrel of oil).
With derivative securities, both parties involved in the contract are essentially betting on the underlying asset’s value changing in opposite ways.
Examples of common derivative securities include futures, forwards, swaps, and options.
Self-regulatory organizations, like the Financial Industry Regulatory Authority (FINRA), help regulate derivative securities.
Investing in Securities
The entity that creates the securities for sale is known as the issuer, and those who buy them are, of course, investors.
Generally, securities represent an investment and a means by which municipalities, companies, and other commercial enterprises can raise new capital.
Companies can generate a lot of money when they go public, selling stock in an initial public offering (IPO), for example.
City, state, or county governments can raise funds for a particular project by floating a municipal bond issue.
Depending on an institution’s market demand or pricing structure, raising capital through securities can be a preferred alternative to financing through a bank loan.
On the other hand, purchasing securities with borrowed money, an act known as buying on a margin is a popular investment technique.
In essence, a company may deliver property rights, in the form of cash or other securities, either at inception or in default, to pay its debt or other obligation to another entity.
These collateral arrangements have been growing of late, especially among institutional investors.