Security
Security is a financial asset that is bought and sold (traded) mostly in the exchange for cash or another asset. The nature of a security varies depending on the jurisdiction in which it is traded. The securities traded in Indian markets may be under different rules and regulations than those traded in the US markets.
A company or any entity that issues the securities is referred to as Issuer, and the buyer is called an Investor. Companies need to raise new capital for further expansion, introducing new products, or sometimes pay their debt.
Securities are the most common method for a commercial enterprise to raise new capital. The attractiveness of securities depends on the financial strength and earnings capacity of the firm issuing them.
Types of Securities:
The securities are broadly classified into Equity, Debt, & Hybrid instruments, and Derivatives.
Equity Securities:
Equity or Common Stock represents the ownership interest in a company or business firm issuing the shares. The shareholder is a part-owner of the company. A single share does not equal even a billionth part in large companies like ONGC, TCS, RIL, etc. So you are a minute part-owner of every company for every share you purchase and hold in your demat account.
Equity shares or common stock are the most commonly traded securities in the financial or stock markets. The price of the shares varies according to the performance of the company in the long term and their demand & supply in the stock exchanges in the short term.
Profits from purchasing shares include dividends paid by the related company (issuer) and raise in the price of a share in the stock markets; it is capital appreciation of a share. Companies provide voting rights to their shareholders.
Shares prices are subject to wide fluctuations in the stock markets. Therefore, shares or stocks are riskier than debt instruments such as Bonds and Certificates of Deposits. Buying the shares of a low-quality company at a high price will put in a lot of trouble. The market price of such stocks might be equal to zero if the exchanges delist that company.
Debt Securities:
Debt, as you know, is borrowed money or credit from other entities such as banks, financial institutions, etc. The borrower must paid back that principal along with prefixed interest. Debt securities have predetermined interest rate and maturity date.
Corporate Bonds, Government Bonds, Certificates of Deposits, Debentures, etc. come under debt securities. The buyer of these securities does not have ownership and voting rights in the issuer companies. It is basically lending money to the company in return for a fixed rate of interest paid.
Bonds belonging to Government and High-Grade Corporates are the most traded and safe debt securities in the stock markets.
The safety of bonds depends on the financial strength of the issuer. Normally, the bonds issued by the secondary companies with average balance sheets pay higher interest rates compared to those of government and large corporate companies with strong fundamentals. Be very cautious if you find bonds of a company promising very high interest rate, like more than 10%, in Indian markets as of the current market conditions in 2022.
Hybrid Securities:
As the name implies, these securities are hybrids between stocks and bonds. These are convertible securities from debt to equity or ownership. Preference Shares, Equity Warrants, and Convertible Bonds are the best examples of such securities. This is a complicated section. I will provide more information on these securities in the upcoming articles.
Derivatives:
A Derivative is a contract that gets its value based on performance of an underlying asset. Basically, derivatives are like betting against the price of the underlying assets in the upcoming future. The most common derivatives are forwards, futures, options, and swaps.
These are the most complex category of securities, and a new investor should be away from the derivatives. By far, derivatives are the riskiest of all the securities.
Derivatives are speculative in nature. The buyer of derivatives does not necessarily have ownership of the underlying asset. More about these in the upcoming articles.
For your information, derivatives of unsecured home mortgage loans are the main reason for the 2008 stock market crash. It was Coronavirus scare in 2020 that provoked stock markets to tank. Where, stock markets all over the world had witnessed one of the worst crashes in the history.
Disclaimer:
I provide the information and my views on the website only to educate new investors, stock market enthusiasts, and the common public on equity or stock market investments. Please consult your financial adviser before making any investments in the stock market. In case of any queries, you can contact me via email ID or Contact Form.
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