You might have heard the term "securities" but might not fully understand what it means. Simply put, securities are financial instruments that represent ownership or a claim on assets. They come in different forms such as stocks, bonds, investment contracts, notes, and derivatives, each serving a specific purpose in the financial world.
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What are securities?
Securities are financial tools that people buy and sell to invest money or raise funds. They represent ownership in a company, a loan to a government or corporation, or a right to trade assets.
For example:
- Stocks are securities that give you a share of ownership in a company. If the company does well, you might earn money through dividends or selling your shares at a higher price.
- Bonds are debt securities where you lend money to a government or company. In return, you get regular interest payments and your initial investment back when the bond matures.
- Options are financial derivatives that give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed-upon price and date.
Types of securities
- Equity securities: These are shares or stocks that represent ownership in a company. When you buy equity securities, you become a part-owner of the company. This means you can earn money if the company does well and may also have a say in company decisions.
- Debt securities: These include bonds and notes where you lend money to a company or government. In return, you receive regular interest payments and get your original amount back when the security matures. It’s like a loan where the issuer promises to repay you.
- Hybrid securities: These combine features of both equity and debt securities. For example, convertible bonds are bonds that can be changed into company stock. They offer the stability of bonds with the potential for stock gains.
- Derivative securities: These are financial contracts that derive their value from an underlying asset, like stocks or bonds. Examples include contracts for differences (CFDs), options and futures. They can be used to hedge risks or speculate on price changes.
- Asset-backed securities: These are securities backed by a pool of assets, such as mortgages or loans. Investors receive payments based on the cash flow from these assets. For instance, mortgage-backed securities are backed by home loans.
How securities trade
- Publicly traded securities: These are listed on stock exchanges like the New York Stock Exchange (NYSE). When a company wants to raise money, it can sell shares to the public through an Initial Public Offering (IPO). After the IPO, these shares are available for trading on the stock exchange. Investors can buy and sell these shares easily through brokers, and the prices are determined by supply and demand in the market. This public trading provides high liquidity, meaning you can quickly buy or sell shares.
- Over-the-Counter (OTC) trading: Some securities are not listed on stock exchanges and are traded directly between buyers and sellers. This is called over-the-counter (OTC) trading. OTC trading usually occurs through electronic platforms or by phone, and is often used for securities that are not listed on major exchanges. This method is less formal and can be more flexible, but it might have less liquidity compared to exchange trading.
- Private placements: Securities can also be sold privately to a small group of qualified investors. This is known as a private placement. These securities are not available on public exchanges and are often used by companies that want to raise funds without going public. Because private placements are not widely traded, they are less liquid, meaning it can be harder to sell them quickly.
- Secondary market: After the initial sale, securities are traded among investors in the secondary market. For instance, if you own shares of a company and want to sell them, you do so in the secondary market. This market provides a way for investors to adjust their portfolios and ensures that securities can be bought and sold even after the initial issuance.
What is the difference between stocks and securities?
| Aspect | Stocks | Securities |
|---|---|---|
| Definition | Shares that represent ownership in a company. | A broad term for financial instruments like stocks, bonds, options, and more. |
| Type | A specific type of security. | Includes various types of financial instruments, not just stocks. |
| Ownership | Buying stocks means owning a part of a company. | Securities can represent ownership (stocks), a loan (bonds), or rights (options). |
| Example | Microsoft (MSFT) shares, Apple (AAPL) shares. | Microsoft shares (equity security), U.S. Treasury bonds (debt security), stock options (derivative security). |
| Purpose | To provide investment in a company’s equity and potential profits. | To raise funds or offer investment opportunities with different features and risks. |
| Trading venue | Traded on stock exchanges like NYSE. | Can be traded on exchanges (stocks) or over-the-counter (bonds, options). |
| Risk and return | Stocks can offer high returns but also come with higher risk. | Risk and return vary depending on the type of security (stocks, bonds, options). |
Summary
As you've seen, securities are a diverse range of financial instruments that include stocks, bonds, and other investment contracts. They play a crucial role in personal finance by providing opportunities for investment and savings, while also helping companies raise capital. However, securities should not be confused with just one type of investment; they encompass various forms, each with its own characteristics and risks.
Source: investopedia.com
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