What is financial security? Definition, examples and FAQ

Financial securities have value and can be bought, sold and traded.

What is financial security?

At a basic level, a security is an asset or financial instrument that has value and can be bought, sold or traded. Some of the more common examples of securities include stocks, bonds, options, mutual fund stocks, and ETF stocks. Securities have certain tax implications in the United States and are subject to strict government regulation.

Title characteristics

  • The titles are fungible. In other words, they are assets that can be quickly and easily exchanged for others of the same type. Just as any nickel can be replaced with any other, any stock of a company can be replaced with any other stock of the same company. While the nickels and shares of a company can change in value over time, at any time, all nickels are worth the same amount and all shares of a specific company are worth the same amount.
  • In the United States, the trading of securities is regulated by the SEC (Securities and Exchange Commission), a regulator of the United States government.
  • The legal definition of a financial guarantee varies by country and jurisdiction.
  • Securities are generally divided into four general categories: debt, equities, hybrids and derivatives.

The 4 types of titles

Financial securities are divided into four general categories: debt securities, equity securities, hybrid securities (which have characteristics of both debt and equity securities), and derivative securities.

1. Debt securities

Debt securities, such as corporate bonds, government bonds, and certificates of deposit, are primarily loans. They act as IOUs from a government or a corporation to the holder of the debt obligation. Owners of debt securities lend a certain amount of money (the principal) to another party. This party is then obliged to pay predetermined interest to the owner at regular intervals according to the conditions specified in their agreement until the maturity of the instrument, at which point the debtor must repay the owner of the collateral up to the principal.

The purpose of a debt instrument (like a bond) is twofold. On the one hand, it allows a company, government or other entity (the borrower) to temporarily use the capital of the owner of the security. On the other hand, it allows the owner of the security to receive regular interest payments for a period of time in exchange for the temporary use of his money before returning it in full to him on a certain agreed date.

2. Equity securities

Equity securities indicate partial ownership of an entity, often a business. The most common example of an equity security is a share of the stock of a company. Shares of mutual funds are also considered equity securities, as are stocks of some ETFs (those that do not include debt securities like bonds).

While individuals buy debt securities in order to receive periodic payments in exchange for the temporary use of their money, individuals generally buy equity securities as investments with the aim of achieving capital gains over the years. time. An equity security is an asset, so if its value increases, the party that owns it can sell it for a profit.

While most equity securities generally do not entitle their holders to periodic payments, some do, and these payments are called dividends. Companies that pay dividends use a small percentage of their profits to pay shareholders a certain amount per share, usually quarterly or annually. Since equity holders are partial owners of an entity, they are also often entitled to certain voting rights when it comes to some of that entity’s business decisions.

Generally, equity securities offer higher potential returns than debt securities because the value of a business or entity is technically unlimited, while the value, interest, and maturity of a company. obligation are fixed and predetermined. However, equity securities also carry higher risk. Although the potential value of a business or entity is unlimited, that value could also move in the negative direction, resulting in capital losses for shareholders. If a company goes bankrupt, its shareholders are not entitled to their share of the remaining value until the company has paid all of its creditors and fulfilled all of its obligations under the terms of the bankruptcy.

TheStreet Dictionary Terms

3. Hybrid securities

Hybrid securities behave like debt securities in some ways and like equity securities in other ways. The most common type of hybrid security is a convertible bond. These behave like bonds in that they involve regular payments, but they differ from bonds in that they can also be converted into a specific number of shares of a share at the discretion of the holder. Another example is a stock purchase warrant, which is an option issued directly by an entity to its shareholders to buy or sell a security at a specific price on or before a specific date.

4. Derivative securities

A derivative is a security whose value is based on a specific asset or group of assets (such as a stock or commodity). A derivative usually takes the form of a contract between two parties to buy or sell a specific asset or pool of assets. Derivatives are often used by individuals and institutions to mitigate risk, but they can also be used speculatively by investors to make money.

A common derivative is a futures contract, which is an agreement to buy or sell an asset on a predetermined future date for a specific price. If someone bought a futures contract that allowed them to buy a bale of hay for $ 35 in three months, but three months later the hay bales were worth $ 45, the buyer would realize a gain of $ 10. Futures contracts behave the same way, but they are more customizable and generally carry more risk for both buyer and seller.

Option contracts are also common. These behave like futures contracts, but instead of the buyer being forced to buy or sell a specific security at a specific price at a specific time, they simply have the option of doing so.

Another common derivative is a swap, which is an agreement between two parties to exchange one cash flow for another. One cash flow is generally fixed (like a fixed interest rate) and the other is generally variable (like a variable interest rate). Sometimes companies exchange loan interest rates in different currencies to take advantage of exchange rates.

Examples of common titles by type

The four types of securities are debt securities, stocks, hybrids and derivatives.

Debt Equity Hybrid Derivative

Corporate bonds

Ordinary actions

Convertible links

Futures contracts

Government bonds

Preferred stock

Convertible preferred shares

Before

Certificates of deposit

Mutual fund units

Share subscription warrants

Options

Certain ETF stocks

Certain ETF stocks

Certain ETF stocks

Trades

Graph with "Risk" like the Y axis and "To recover" like the X axis showing bonds and CDs have the lowest risk and reward, mutual discoveries and ETFs have higher risk and reward, and individual stocks have even higher risk and reward

Some securities, like bonds and CDs, have lower risk and relatively low potential returns, while others, like individual stocks, have higher risk and higher potential returns.

Frequently Asked Questions (FAQ)

This section includes answers to some of the most frequently asked questions about securities and other information that may be helpful.

Are currencies like dollar securities?

Technically, no – currencies, in theory, are simply stores of value that individuals and institutions can use to pay for goods and services. In practice, however, currencies can be bought, sold and traded strategically, just like stocks, by individuals or institutions who wish to speculate on how exchange rates may vary in the future. In other words, the main purpose of money is not to act as security, but many people use it as such.

Are cryptocurrencies like Bitcoin securities?

Again, no, the primary purpose of a cryptocurrency is to be a decentralized, independent store of value from a central banking system like the Federal Reserve that can be used to pay for goods and services (everything as a fiat currency). In the long term, the crypto community looks to decentralized digital currencies like Bitcoin as a possible replacement or alternative to traditional currency. That being said, many individuals and institutions use cryptocurrencies as securities by buying, selling, and trading them speculatively for profit without any intention of spending them on goods and services.

Are NFTs (Non-Fungible Tokens) transferable securities?

Since NFTs are generally not used to pay for goods or services, and their value depends on what buyers are willing to pay for them at any given time (such as a collectible collectible card or stocks in a company), NFTs behave very similarly to certain securities. apart from the fact that they are not traded on an exchange. That being said, they are also used to represent ownership of real and digital products, and in this way, they behave more like certificates of authenticity. Additionally, NFTs cannot be easily mixed with other securities and are not traded on most securities trading platforms. Most authorities don’t consider them to be titles, but they exist in a gray area, so how they are categorized may change in the future.