One of the most common and important terminologies someone will encounter in finance and the specific realm of investing is security or securities. This term represents different forms of financial instruments and several asset classes that have value and can be traded. However, in some cases, because they represent different instruments or assets, they can be confusing. Investors and other individuals involved in finance need to understand what securities are and their common types and examples.
Understanding What Securities Are and Their Common Types and Examples
General and Specific Definitions
Securities are fungible and tradable financial instruments. They are called fungible because one unit of security is considered the same as another, and they can be exchanged without any loss of value. They are also considered tradable because they can be bought and sold in markets. Nevertheless, in considering their main purpose, organizations use securities to raise capital in public and private markets, and investors trade them due to their earning potential.
It is important to note that securities are called as such because they are secured by a financial contract that they represent. Their issuance by an organization and their purchase or ownership by an investor specifically represent a financial agreement between these two parties. The term reflects the idea that someone holds a tradable document or record that represents something of value and that the claims on financial assets can be held or transferred securely.
The legal definition of securities varies by jurisdiction. For example, in the United States, a security is a tradeable financial asset of any kind. However, in the United Kingdom, the term applies only to equities, debentures, alternative debentures, and other financial instruments like government securities, warrants, pension schemes, and rights to investments, among others. Some countries also use the term to refer to whatever form of financial instrument that is tradeable.
It is also worth mentioning that the public issuance and sales of securities are regulated by the national government under a specific government agency or office. The Securities and Exchange Commission oversees the sales of equities and debentures in the United States. In the United Kingdom, this responsibility falls under its Financial Conduct Authority. The European Securities and Markets Authority is the main securities regulatory body in the European Union.
Types and Examples of Securities
It is important to reiterate the fact that the term “securities” represents a broad term for different fungible and tradeable financial instruments. There are four main types of securities. These are equities, debentures, derivatives, and hybrid securities. The following are the details of each:
• Equities: These are also known as stocks and shares. They represent ownership in a company. Companies issue them to raise capital from investors. An investor who buys a stock or share essentially owns a piece of the issuing company. There are two types of stocks based on rights. These are common stock and preferred stock. A common stock grants its holder the right to elect board directors but is paid last in liquidation. A preferred stock entitles its holders to a higher claim on the distribution of profits and liquidation.
• Debentures: Debentures or debt securities are also called bonds. There are different issuers of bonds and there are also different types of bonds. Holders of bonds are typically entitled to the payment of principal and interest, alongside other contractual rights. These bonds can also be protected by collateral or may be considered unsecured. Examples of issuers include companies or industrial entities, financial institutions like banks, national governments and local government units, and supranational organizations.
• Hybrids: These represent a combination of equity and debt. They are also called hybrid securities. They can have some of the features of both equity and bond, such as fixed interest rates and the potential for dividend payouts. Specific examples of hybrid securities include equity warrants, preference shares, in-kind toggle notes, convertible bonds, and convertible preferred stocks. It is important to note that some hybrids are sometimes called equities, for convertible preferred stocks, or debentures, for convertible bonds.
• Derivatives: Another type of securities that involve financial contracts whose value is derived from the value of an underlying asset are collectively called derivative securities or derivatives. Common examples of these securities are futures contracts, options, and swaps. Specific examples of underlying assets include stock, bond, commodity, and currency. The common uses of these securities include generating income, hedging other investments, and speculating on short-term or long-term future price movements.
