What Are Securities in Finance?
A security is a financial asset and investment that has value or represents debt and is tradeable. Securities help companies raise capital for projects, expansions, and other expenses. When you buy stocks for your portfolio, you’re investing in a small share of rights to ownership in a company or in a small portion of the debt. Your goal is to be able to sell this stock at a higher price than you originally paid for it.
Depending on the type of security you bought to build your investment portfolio, it may represent your share of ownership or your share of debt. Understanding the types of securities in finance, the trading process, and how they’re regulated may help you decide if you want to expand your portfolio to include these types of investments.
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Equity Securities vs. Debt Securities
There are two common types of securities: equity and debt securities. There are also hybrid securities that take on the characteristics of both these types of investments. Learning more about these security types will help you decide which ones could be profitable short-term investments or long-term investments for you.
Equity securities represent a small percentage of ownership interest in a company, partnership, or trust. In most cases, these securities are considered common stocks, which means the shareholders are paid dividends and have voting rights. As an owner of equity securities, you aren’t entitled to regular payments from company profits, even though you do technically own a small part of the company.
While it’s rarer to find, some equity securities are preferred stock. If you hold preferred stock equity securities, you receive dividends before common stockholders. While you don’t have voting rights, you may have a more steady stream of income for your investment.
You may earn dividends with equity securities but the main way you’ll make a profit is by selling them for more than you originally paid for them. For example, you bought 100 shares of equity securities in Company X for $5 each. After holding onto this stock for six months, you sell it for $8 per share, earning capital gains on your investment.
Debt securities are small pieces of debt with different payback terms, such as a specific interest rate or maturity date. The most common types of debt securities are investment bonds, certificates of deposit (CDs), or collateralized securities, which are securities tied to a pool of loans. Debt security investors are paid interest regularly as the debt is paid back. If they maintain ownership of debt securities through maturity of the loan, they’re also entitled to the repayment of the principal.
Debt securities are valuable because they’re a promise that the loan will be paid back with interest. However, most investors purchase debt securities with the intention of selling them for more than they bought them. If you own debt securities, you’ll receive regular interest payments unless you sell these securities. If you keep securities throughout loan maturity, you’re entitled to your portion of the principal of the loan when the company pays it back.
Hybrid securities are financial assets that include characteristics of both debt and equity securities. Convertible bonds, or bonds that can be converted to stocks, are one common example of a hybrid security. Convertible bonds represent debt but their value is also influenced by stock value in the market, which illustrates how these securities are a hybrid between debt and equity.
Since hybrid securities usually include complex investment and profit structures, they can be tough to trade or sell. However, hybrid security holders are usually paid interest or dividends on their investments, which is how they make their money. Some types of hybrid securities also provide investors with their face value upon maturity.
The Security Trading Process
Most securities are traded on major stock exchanges. Companies that have debt or equity securities available list them for sale on an exchange such as the New York Stock Exchange (NYSE) or Nasdaq. A regulated stock market is generally more attractive for investors because financial statements are transparent and the market is more active.
However, securities may also be traded over the counter (OTC), or outside of one of the major stock exchanges. Investors and brokers directly trade securities OTC without much regulation.
Companies may utilize the OTC market if they don’t want to incur the costs of trading publicly on a major exchange or if their company has been delisted from the exchange. Companies may also engage in OTC security trading if their stock value has dropped too low, often referred to as penny stocks.
Securities may be traded on the secondary market, also referred to as the aftermarket. When bought and sold on the secondary market, security ownership is simply transferred from one investor to another. Investors make profits from capital gains they realize from the sale of the securities.
Regulation of Securities
The U.S. Securities and Exchange Commission (SEC) is responsible for regulating the offering, sale, and trade of securities. To sell or trade securities, issuers must register and file their intent with the securities department of the SEC.
Other self-regulatory organizations (SROs) also take on the role of regulating security trades. One of the most well-known SROs is the Financial Industry Regulatory Authority (FINRA).
These organizations, along with the SEC, require companies to file financial statements and ensure securities meet regulations. To be legally traded on the stock exchange, securities must have investment contracts, form a common enterprise, provide the issuer with the promise of a profit, and use a third party to promote offers.
If you’re attempting to diversify your investment portfolio, you could earn dividend payments and capital gains through securities. You may choose to invest in equity, debt, or hybrid securities, depending on how you plan to make a profit from your investment.
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