What are Securities? And why you should care


Securities are financial investments which allow you to own things without physically holding on to them.

Securities are financial instruments (investments) traded on a secondary market which represent ownership or debt or other economic entitlement with respect to a company. They include things such as mutual funds, stocks and bonds.

Securities give you ownership of the underlying asset with less cost, stress or risk. They have a liquid market, their prices are based on the underlying asset and they are easy to understand.

Some securities are marketable which means they can be easily sold while others are non marketable which means they are hard to sell.

Types of securities

  • Debt securities
  • Equity securities
  • Derivative securities

Debt securities

Debt securities include loans such as bonds.

Bonds are debts issued by a company or government.

Bonds are fixed income investments where borrowers loan money to an organisation or government in exchange for interest. This interest is either paid periodically with coupon bonds or at the end of the loan term upon maturity of the bond with zero coupon bonds.

Bonds are given ratings from rating companies such as standard & poors, moody’s and fitch.

Borrowers with low ratings will usually have to raise their interest rates much higher than those with high ratings in order to attract a sufficient amount of lenders. Lenders will usually go for bonds with low ratings( also known as junk bonds) as they offer great interest rates.

Bonds can either be corporate bonds or government bonds (also known as sovereign debt)

You can buy bonds through a broker or as part of a mutual fund.

Equity Securities

Equity securities usually refer to shares. Shares represent ownership in a company.

You can buy stock through a broker, directly or by buying mutual funds, index funds or ETFs which have a basket of stocks selected already. The secondary market for stocks is the stock market which includes exchanges such as the New York stock exchange and the London stock exchange.

You can also invest in stocks through IPOs. IPOs or Initial Public Offerings are a means through which private companies become public for the first time by selling stocks at a predetermined price to investors. Investors have to hold these stocks for a certain time limit before they can begin trading them and at this point the price cold have fallen or risen. In most cases stock prices rise immediately after an IPO.

IPOs are usually done with the help of an investment bank such as Morgan stanley, JP Morgan or Goldman Sachs. They assist with selling stocks to investor prior to the company going public.

Derivative securities

Derivative securities are securities which get their price from the underlying value of the assets such as stocks, bonds etc. They give the investor an opportunity to make money by betting on which way the price of an asset will move. With derivatives you don't actually buy the asset.

There are a few types of derivative securities, they include:

Stock options
Put options
Call options
Future contracts

What are Stock options?

Stock options allow you to bet on stock prices without having to buy them. You pay a small transaction for having the right to execute a stock option. Stock options can be executed by either doing a put option or a call option on a particular stock.

What is a Call option?

A call option is when you purchase the rights to buy a particular stock at particular date for a particular price. You don't have to follow through by exercising your right but if the stock price goes up and your call option is at a lower price then you can exercise your call option and purchase the stock at your agreed lower price and then immediately sell it for a profit or hold on to it. A call option is usually used by investors who are looking to buy a particular stock.

What is a put option?

A put option is the opposite of a stock option, it gives you the right to sell a stock at a particular date for a particular price. You don't have to exercise this right but you may want to exercise it in a scenario the stock price falls lower than the price you bought it and your put option has a higher price than the current stock price. By exercising your put option you will essentially avoid making a bigger loss or any loss at all on your stock investment.. A put option is usually used by investors who are looking to sell a particular stock they already own.

What is a futures contract?

Futures contracts are just like call or put options as you agree to buy or sell at a certain price on a certain date. The only difference is that with futures contracts these are actually binding agreements and you have to exercise your right.

Future contracts are derivatives but they are focussed on commodities such as currencies, oil, natural gas and gold.

There are also asset backed securities which get their price based on the expected returns from a package of underlying assets e.g mortgages, bonds, loans etc.

Asset backed securities are divided into tranches based on their risk ratings and sold onto investors. Investors can also take out futures contracts on those asset backed securities.

How securities affect the economy

Securities make it easier for money to flow throughout the economy. They allow those who need to raise capital meet those who are looking to invest by providing a financial instrument which meets the needs of the investors. Investors can track stock prices, bond prices, asset prices etc and invest or exist investments at prices that suit them.

Derivatives also make the market and companies more efficient as the money chases companies who are performing well and is withdrawn from those who aren't. These forces companies to look for way to be more innovative and be more focussed towards profit generation.

Derivatives aren't always good to the market as they can easily affect stock prices when investors make decisions without enough research due to how easy derivatives are to obtain. This means stock prices can react negatively to the price action of derivatives and cause a crash in the market.

Derivatives also increased volatility in the market by making it too liquid. Investors were always willing to purchase asset backed returns or bonds and in doing so encouraged lenders who packaged these loans to lower their lending criterias and instead lend as much to consumers and then sell these loans on to investors in different packages based on risks.

Investors who invested in derivatives typically did not understand how they worked and how the underlying assets were packaged. When these loans started to default in 2008 this led to widespread panic and the lenders didn't know how to price the derivatives to sell them on which eventually led to their collapse and the 2008 financial crisis.

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