A security is a tradable financial instrument, such as stocks and bonds. This definition can be found in the dictionary. We use it to describe many different types of investments that are made for capital gain or income. It is important not to confuse “security” with “safety.” Many of these investments carry risk.
There are many different types of securities that you may read about in the news or hear your friends talking about. These include stocks, bonds, futures, options and ETFs (exchange traded funds). Each security is unique with its own set of risks and rewards associated with it.
What makes a security?
A security is an asset that can be bought or sold on public markets like NASDAQ or NYSE. It also has to have value based on some type of external data point such as revenue, profit margin etc… There must be transparency for investors by having information readily available so they know what kind of investment they are making. For example, if someone invests $100 into ABC company’s stock through their brokerage account then the investor should be able to find out information on ABC company’s website.
The security must also have a clear ownership structure so that it can easily be traded between investors. For example, when you buy Apple stock, you become an owner of the company and are entitled to dividends (if any) and voting rights.
Now that we know what a security is, let’s look at some of the different types of securities and their associated risks.
Types of Securities
There are three types of securities which are stocks, bonds and derivatives.
A stock represents equity in a company and gives the holder voting rights as well as potential dividends. When you buy a stock, you become an owner of the company and are entitled to these benefits. However, stocks also carry risk as the price could go down if the company performs poorly. For this reason, it is important to do your research before investing in any stock.
Bonds are loans made by investors to companies or governments with fixed interest rates and maturities. As an investor, you are essentially lending your money to an issuer who promises to pay you a certain amount of interest over the life of the security and return your original investment at maturity. This security is less risky than stocks because there is a set rate of return, but it also pays a lower yield when compared with other securities such as stocks or mutual funds
Derivatives are contracts that derive their value from underlying security, asset or index performance. They can be used for hedging (reducing risk) or speculating (seeking profit). For example, let’s say investors expect Apple stock price will go up in the next year so they buy call options which gives them right to buy shares at $100 per share by January 2018 regardless if market price is above or below that price. If the stock price does go up, the call option will be worth more than what was paid for it and the investor can sell it at a profit. However, if the stock price goes down, the call option becomes worthless.
What about derivatives?
Derivatives are one of the most complicated securities out there making investing in them very risky for inexperienced traders who don’t fully understand what they are doing yet unfortunately these products made up 87% of the total notional value outstanding in the world’s derivatives markets according to the Bank for International Settlements. So what exactly is a derivative security? A derivative security is a contract between two or more parties whose value is based on an underlying asset, index or reference rate. These contracts can be used for hedging (protecting) investments against price movements or speculating on whether the price of the underlying security will go up or down. For example, if you think oil prices are going to rise in the future you could buy a futures contract which would obligate you to purchase oil at a certain price at some point in the future regardless of whether or not you still want it!
Derivatives can be extremely useful products when used correctly but they also have the potential to be extremely dangerous when misused.
Residual security is a type of security that allows you to participate in the appreciation (or depreciation) of an asset.
For example, let’s say it costs $100 for each share and there are 100 shares total to be sold. After all 100 shares have been sold the issuer (seller) will “reopen” or repurchase any remaining unsold securities at whatever price they wish because these shareholders no longer have exclusive ownership over their assets. The issuer may choose not to reopen again after this point but if they do then shareholders would need to purchase new stocks which could potentially cost more than initially expected so residual security holders should be aware before making any future investments!
Investors should always ask themselves: What can I invest in that will give me residual security ownership?
There are a few types of securities that offer investors this type of protection:
- Preferred stock
- Convertible bond
What about convertible bonds?
A convertible bond is a type of security that allows the holder to exchange the bond for shares of common stock at a predetermined price called the conversion rate. This can be advantageous for the issuer because they can raise money without giving up any ownership in the company. For security holders, they are essentially buying a security that has an option to become another security at some point so this is why it’s important for investors to understand whether or not their convertible bond will ever be converted and what the conversion price is!
Other Types of Securities
- Certificated securities: security certificates issued by a clearing agency or security registrar. The security is registered to the owner in book-entry form only and no certificate is physically delivered as part of the transaction.
- Book entry securities: security that exists on an issuer’s books as entries rather than physical documents, which eliminates transfer agents and their fees for this service. Book-Entry means it doesn’t exist physically but rather electronically! Anyone who wants full details about what they’ve invested in must go through the issuer directly so be very careful when investing with your broker because you could lose all of your money without even knowing until it’s too late!
- Publicly traded securities: any security listed on one of several public stock exchanges such as NYSE (New York Stock Exchange), NASDAQ (National Association of Securities Dealers Automated Quotations), or Amex (American Stock Exchange).
- Privately traded securities: security that is not listed on a public stock exchange and instead is bought and sold over-the-counter between investors.
- Over the counter (OTC): security transactions that take place away from an organized securities market, typically through dealers.
- Penny stocks: low priced speculative stocks issued by small companies with limited operating histories or financial resources. Penny stocks are often quoted over the counter.
Investing in Securities
Securities are some of the most common investments that people make to grow their wealth. There are many reasons why they work so well including diversification, liquidity and security. Diversification is when an investor spreads risk across multiple securities instead of just one. This way if you invest in a single security there is less chance it will lose value because it isn’t completely dependent on one asset or market performance which can be more risky than investing in several different stocks/bonds/derivatives at once! Liquidity means security prices change frequently meaning someone buying your security today could get a better deal tomorrow (or vice versa). Investing gives investors access to these markets around the clock, even while; getting them exposure to different opportunities around the globe.
Investors use a variety of security types to create their desired risk and return profiles. A security’s risk is its potential to lose value which usually increases as you move down the ladder from government bonds, corporate bonds, stocks and derivatives. The higher the risk, the higher potential for gain (or loss). Conversely, securities with lower risks generally offer lower yields when compared to those with greater risks. For example, an investor may want to buy a stock that pays dividends every quarter versus a bond that only pays interest once at maturity since they are looking for regular income payments instead of waiting until the bond matures years down the road
When buying or selling a security there are two important things you need to know: what security you are buying/selling and the security’s price. The security can be anything from stocks, bonds or derivatives but it needs to have a ticker symbol (a unique identifier) for investors to know which security they’re dealing with at any given time. A security’s price is its value in dollars because all investments have an underlying dollar amount attached them that changes over time depending on market forces so knowing how much your investment is worth when deciding whether or not to sell will help you make better decisions!
How Securities Trade
Securities are bought and sold on exchanges. An exchange is a marketplace where investors can buy and sell securities. The most well-known exchanges are NASDAQ and the New York Stock Exchange (NYSE). When you buy or sell a security, your order goes through an exchange.
Exchanges work by matching buyers and sellers of securities. For example, let’s say I want to buy Apple stock. I go to my brokerage account and enter in how many shares I want to purchase and at what price. My broker will then look for someone who wants to sell Apple stock at that same price. Once they find a seller, the broker will execute the trade which means he will buy the stock from the seller and give me the shares I wanted while the seller gets my money. The security will then be transferred from the seller’s account to mine and I can now sell it on another exchange if I choose.
Trading securities is very similar in all exchanges except for one thing: different exchanges have liquidity (volume) at different times of day which means there may not always be someone who wants to buy or sell your security when you want them too. For example, NASDAQ has a lot more volume during business hours compared with NYSE because that is when most Americans are working so they don’t have time to trade but also many foreign investors are online looking for opportunities making this market open 24/hrs a day to accommodate everyone around the world! This trading much easier since buyers and sellers are always available.
Regulation of Securities
The security market is regulated by many governing bodies around the world but the most important one in the United States is the Securities and Exchange Commission (SEC). The SEC was created in 1934 to regulate the securities markets and protect investors. They do this by enforcing laws and rules related to securities trading, disclosure requirements and corporate governance. In addition, they also provide education to help investors make informed decisions about where to invest their money.
Public offerings, sales, and trades of U.S. securities must be registered and filed with the SEC’s state securities departments. Self Regulatory Organizations (SROs) within the brokerage industry often take on regulatory positions as well. Examples of SROs include the National Association of Securities Dealers (NASD), and the Financial Industry Regulatory Authority (FINRA).
That concludes our overview of what a security is! We hope this was helpful and informative. As you can see, there are many different types of securities with their own unique set of risks and rewards. It’s important to do your research before investing in any security to make sure you understand what you’re getting into. As always, please let us know if you have any questions or comments. Thanks for reading! 🙂