Types of Securities in Finance

What are the type of securities in finance?- Explained

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Author: Sarthak Bhalerao

Introduction:

The first thought that comes to your mind before investing is what to invest in? Making investment decisions is very important if you wish to grow your wealth. Investing in securities is one of the best ways to invest and build your wealth. In the financial field, there are many types of securities that are tradable. Let’s go over the types of securities, their benefits and how they work.

Table of contents:

  1. What is security?
  2. What is the securities market?
  3. Types of securities
  4. Conclusion

What is security?

Security is a financial instrument or asset that holds some monetary value and can be traded either publicly or privately. Securities are represented by a certificate in either a physical form or an electronic digital copy. Some examples of securities are stocks or mutual funds of a certain company, bonds issued by the government or corporations, stock options, etc. [1]

What is the securities market?

In financial terms, the securities market is where securities can be bought and sold based on demand and supply. The securities market 3 levels as follows:

  • Primary Market: The primary market deals with the issue of new securities. Stocks during a certain company’s IPO is done through the primary market.
  • Secondary Market: It refers to the market for used goods or assets. The stock market where the shares are publicly traded is an excellent example of the secondary market.
  • Over The Counter (OTC) Market: OTC trading is done directly between 2 parties without the supervision of an exchange. These types of trades are not necessarily publicly disclosed.

Types of Securities:

  1. Equity Securities: Equity refers to stocks and a share of ownership in a company that is possessed by the shareholder. Equity securities usually generate regular earnings in the form of dividends. The shareholders can profit by selling the stocks (assuming they have increased in value). The equity market is highly volatile as the price of the stock keeps going up and down according to the market and company’s fortune, performance, and well-being. If a business is facing bankruptcy, the equity shareholders share the residual capital after the company pays all their obligations. Common stocks, common shares, preferred shares are a few examples of equity securities.

 

  1. Debt Securities: Debt securities or fixed-income securities represent borrowed money that must be repaid with terms that stipulate the size of the loan, interest rate, maturity, or renewal date, etc. Debt securities are very much safer as compared with equity securities, but they also have low returns. Debt securities include government bonds, corporate bonds, debentures, where the holder must make regular payment of interest and repayment of the principal amount. These are typically issued for a fixed term and at the end of which the issuer can redeem the securities. The daily trading value of debt securities is more than equity because debt securities are largely held by institutional investors, governments, and NGO’s. [2]

 

  1. Hybrid Securities: Hybrid securities combine the characteristics of both equity and debt securities. Most banks and organizations choose hybrid securities to borrow money from the investors. Like bonds, they promise to pay a higher interest at a fixed or floating rate until a certain time in the future. Unlike a bond, the number of interest payments is not guaranteed. They can even be converted into shares, or the investment can be terminated at any given time.

 

  1. Derivative Securities: Derivative securities are financial instruments whose value depends on basic variables such as stocks, bonds, currencies, interest rates, market indices, and goods. The main purpose of these types of securities is to consider and minimize risk and this is achieved by insuring against price movements. There are 4 main types of derivative securities:

 

  • Futures: Futures are an agreement between two parties for the purchasing and selling of an asset at an agreed-upon price in the future. A futures contract is the obligation to sell or buy an asset later at an agreed-upon price.
  • Forwards: Forwards are the same as futures, but they are not traded publicly. Another difference from futures is the risk for both sellers and buyers. The risks arise when one party becomes bankrupt, and the other party may not be able to protect its rights. As a result, loses the value of its position.
  • Options: Options is the same as futures but the key difference between the two types of contracts is that, with an option, the buyer has the right to buy or sell but he is not obliged to do so as long as the contract is in effect.
  • Swaps: A swap is a derivative contract through which two parties exchange the cash flows or liabilities from two different financial instruments. The most common swap is an interest rate swap. They do not trade on exchanges and retail investors usually do not engage in swaps.

Conclusion:

The entity that creates the securities for sale is known as the issuer, and the ones who buys/sells are known as investors. In India, the Securities and Exchange Board of India regulates the public offer and sales of securities. Companies can generate a lot of capital when they go public, selling stock in an IPO, for example. Governments can raise funds for a particular project by floating a bond issue. One can choose in which security he wants to invest in depending on his and goals risk appetite.

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