Financial Securities: An Overview

Financial securities are tradable financial instruments used to raise capital in markets. They represent a claim on the issuer’s assets or future income and can be broadly categorized into debt securities, equity securities, and derivatives.

Debt Securities

Debt securities represent borrowed money that must be repaid over time, usually with interest. They essentially represent a loan made by an investor to a borrower (corporation, government, etc.).

• Bonds: These are fixed-income securities issued by corporations, governments, or municipalities. They pay a stated interest rate (coupon rate) over a specified period and return the principal (face value) at maturity. Bond prices are inversely related to interest rate changes; when interest rates rise, bond prices typically fall.
• Treasury Bills (T-Bills): Short-term debt obligations issued by the U.S. government with maturities ranging from a few weeks to a year. They are sold at a discount and mature at face value, with the difference representing the interest earned.
• Commercial Paper: Short-term unsecured promissory notes issued by corporations, typically used to finance short-term liabilities like inventory or accounts receivable.
• Certificates of Deposit (CDs): Savings accounts that hold a fixed amount of money for a fixed period, and which pay a fixed interest rate. Offered by banks and credit unions.

Equity Securities

Equity securities represent ownership in a company. Investors holding equity securities are entitled to a share of the company’s profits and assets.

• Common Stock: Represents ownership in a corporation, giving the holder voting rights and a claim on the company’s earnings (dividends) and assets after debt holders are paid. Common stock is generally considered riskier than preferred stock or bonds but offers the potential for higher returns.
• Preferred Stock: A class of stock that pays a fixed dividend and has priority over common stock in the event of liquidation. Preferred stockholders generally do not have voting rights.

Derivatives

Derivatives are financial contracts whose value is derived from an underlying asset, index, or interest rate. They are often used for hedging risk or speculation.

• Options: Contracts that give the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) on or before a specific date (expiration date).
• Futures: Contracts that obligate the buyer to purchase an underlying asset or the seller to deliver an underlying asset at a predetermined price and date in the future. Used heavily in commodity markets.
• Swaps: Agreements between two parties to exchange cash flows based on different financial instruments or indices. Common types include interest rate swaps and currency swaps.

The types of securities an investor chooses depend on their individual risk tolerance, investment goals, and time horizon. Understanding the characteristics and risks associated with each type of security is crucial for making informed investment decisions.