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Understanding Investment Securities

Understanding Investment Securities

Beginner

30th November 2019
Updated: 9th September 2020

The securities market is one of the largest and liquid of all financial markets in the world. This market offers an alternative through which companies can raise capital for their operations. Nevertheless, many people don’t understand securities, which underlie the securities market. This article explains securities and the types that are available in the market.

Understanding securities

As an investor, you might be familiar with securities already. Securities are financing instruments that companies use to raise capital in the financial markets. Companies assign value to these instruments, and they act as proof of ownership for the traders who buy them. The evidence of ownership of security could be a piece of paper or (more common nowadays) a digital file stating ownership. 

There are two sides to a security. On one side, the holder of the security views the instrument as an investment. On the side of the issuer, the instrument is a debt or an obligation. Therefore, the issuer of the security commits to pay out a certain sum at a given time, while the owner of the security hopes to earn a profit. Examples of securities include shares of stock, bonds, notes, debentures, warrants, and options.

Stocks and bonds form the primary class of securities. Nevertheless, there is a secondary class called derivatives. Derivatives are financial instruments whose value depends on the value of a benchmark. The instrument comes about after a financial contract between the buyer and the seller is established. The buyer enters an obligation to purchase the benchmark at an agreed price on an agreed date. Derivatives carry more risk than primary securities.

Different types of securities

Securities divide into three major categories, depending on their nature. The categories are:

Equity securities

Equity securities include shares of companies that trade on the stock market. Companies declare the intent to go public via an initial public offering (IPO), which entails giving a piece of its ownership to public investors. After that, investors can trade the stock on the secondary market where an investor can sell to another investor as per prevailing prices. Stockholders earn a regular income in the form of dividends. In addition, stockholders earn a profit when they sell the stock at a higher price than what they paid to acquire it. The price of equity securities depends on the performance of the company and the general trend of the financial markets.

Debt securities

Debt securities are securities that enable organizations to borrow money from financial markets. The most common security that falls under this section is bonds. Governments, government entities, and private or public corporations can issue bonds to raise capital. This form of raising capital can prove especially fruitful when the organizations have trouble securing bank loans. Investors who buy bonds are called creditors because they are lending that particular organization money to finance its projects. The biggest advantage of debt securities is that there is little to no volatility, making them less risky.

Derivatives

Derivatives include all the other types of securities that derive their value from benchmark assets. Benchmark assets include securities like stocks and bonds. Derivatives differ from other securities in that they have a specific price of purchase and repayment, and they mature at an agreed-upon time. Hedge funds and other sophisticated investors trade derivatives to spread risk further within their portfolio. Examples of derivatives include mortgage-backed securities and certificated securities, among many others.

By Harry Atkins
Harry joined us in 2019 to lead our Editorial Team. Drawing on more than a decade writing, editing and managing high-profile content for blue chip companies, Harry’s considerable experience in the finance sector encompasses work for high street and investment banks, insurance companies and trading platforms.
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