Exploring Financial Securities: Illustrations, Varieties, Oversight, and Significance

What Is a Security?

A “security” encompasses various investments like stocks, bonds, and derivatives. It represents ownership in a corporation via stocks, or a creditor relationship through bonds. Securities can also provide rights to ownership as in the case of options.

Key Takeaways

• Securities are financial instruments tradable in public and private markets.
• Three main types of securities are equity (ownership rights), debt (repaid with periodic payments), and hybrids (mix of debt and equity).
• Public sales of securities are regulated by the SEC, while self-regulatory organizations like NASD, NFA, and FINRA oversee derivative securities.

Investopedia / Daniel Fishel

Understanding Securities

The Securities Act of 1933 established federal regulation of the US stock market, requiring disclosure of offering details and company information. It aims to protect investors from misleading practices.

The SEC enforces securities regulations, broadening the meaning of securities beyond traditional stocks and bonds as seen in the Howey vs. SEC case.

The Howey Test determines if an investment is a security based on factors like investment of money and expectation of profit. Courts have applied securities rules to diverse assets, including cryptocurrencies and non-fungible tokens.

Types of Securities

Securities are categorized into equity, debt, and hybrids. Equity signifies ownership in a business through shares of capital stock, while debt involves borrowed money repaid with interest and principal.

Equity Securities

Equity securities offer ownership rights in a company, potential capital gains, and voting rights. In bankruptcy, equity holders have residual claim after creditors.

Holdings of equity securities can provide dividends and profit from selling securities at a higher value.

Debt Securities

Debt securities represent borrowed funds that require repayment with interest, typically issued for a fixed term.

Debt securities like bonds entitle holders to interest payments and repayment, irrespective of issuer performance, with no voting rights.

Hybrid Securities

Hybrid securities blend characteristics of debt and equity. Examples include equity warrants, convertible bonds, and preference shares.

Preferred stock, although classified as equity, functions like a debt security. It offers fixed dividends, making it attractive to income-seeking investors.

Derivative Securities

Derivatives derive value from underlying assets like stocks or commodities. Call options benefit from asset appreciation, while put options gain when asset value decreases.

Asset-Backed Securities

Asset-backed securities represent income from various assets like loans or mortgages pooled and distributed among investors.

How Securities Trade

Publicly traded securities are listed on exchanges for easy trading. Securities can be bought or sold over-the-counter or through initial public offerings to attract investors.

Secondary markets allow shareholders to sell securities for cash or gain. Private placements offer securities to a limited group without public trading.

Investing in Securities

Securities let companies and governments raise capital by selling shares or bonds. Investors can also purchase securities on margin to increase investment potential.

Raising capital via securities issuance can be preferable to loans due to market demand and pricing structures.

Regulation of Securities

The SEC regulates public securities offerings in the US, requiring registration and compliance. Self-regulatory organizations like NASD and FINRA also oversee security regulations.

Residual Securities

Residual securities, like convertible bonds, can be changed into common stock. They provide flexibility for corporations to attract investment in competitive fundraising environments.

Converting a residual security can increase outstanding shares, impacting metrics like earnings per share. Share consolidation, reducing outstanding shares, can boost share value.

Other Types of Securities

Certificated Securities

Certificated securities are physical certificates representing ownership, though electronic systems now handle most securities without the need for physical documents.

Today, global certificates are deposited in systems like the Depository Trust Company for electronic trading without physical certificates.

Bearer Securities

Bearer securities are negotiable assets, allowing transfer between investors. They can aid in tax evasion and are rare in the US due to potential misuse.

Registered Securities

Registered securities list holders’ names in an issuer’s register, with each transfer requiring amendments in the register.

Letter Securities

Letter securities require an investment letter from buyers, stating purchase intent for investment not resale. They involve direct sales from issuer to investor and are not publicly traded.

Cabinet Securities

Cabinet securities are listed on exchanges but rarely traded. They are usually bonds rather than stocks, held by inactive investors.

Issuing Securities: Examples

Startups and governments use securities to raise funds, whether through stock offerings, bond issuance, or private placements.

Securities distribution dilutes founders’ stakes but attracts investment for growth. Founders offer equity or debt securities to investors to fund projects.

What Is the Difference Between Stocks and Securities?

Stocks are a type of security representing ownership in a company, with additional security types like bonds, derivatives, and asset-backed securities available.

What Are Marketable Securities?

Marketable securities are easily traded assets like stocks or bonds, while non-marketable securities cannot be publicly sold, limiting trading possibilities.

What Are Treasury Securities?

Treasury securities are US Treasury-issued debt securities, offering low-risk, government-backed investment options.

The Bottom Line

Securities, essential investment instruments, provide various options for capital raising, investing, and financial growth for individuals and entities alike.