Security (finance)


A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any form of financial instrument, even though the underlying legal and regulatory regime may not have such a broad definition. In some jurisdictions the term specifically excludes financial instruments other than equity and fixed income instruments. In some jurisdictions it includes some instruments that are close to equities and fixed income, e.g., equity warrants.
Securities may be represented by a certificate or, more typically, they may be "non-certificated", that is in electronic or "book entry only" form. Certificates may be bearer, meaning they entitle the holder to rights under the security merely by holding the security, or registered, meaning they entitle the holder to rights only if they appear on a security register maintained by the issuer or an intermediary. They include shares of corporate capital stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, limited partnership units, and various other formal investment instruments that are negotiable and fungible.

United Kingdom and United States

In the United Kingdom, the Financial Conduct Authority functions as the national competent authority for the regulation of financial markets; the definition in its Handbook of the term "security" applies only to equities, debentures, alternative debentures, government and public securities, warrants, certificates representing certain securities, units, stakeholder pension schemes, personal pension schemes, rights to or interests in investments, and anything that may be admitted to the Official List.
In the United States, a "security" is a tradable financial asset of any kind. Securities can be broadly categorized into:
The company or other entity issuing the security is called the issuer. A country's regulatory structure determines what qualifies as a security. For example, private investment pools may have some features of securities, but they may not be registered or regulated as such if they meet various restrictions.
Securities are the traditional method used by commercial enterprises to raise new capital. They may offer an attractive alternative to bank loans - depending on their pricing and market demand for particular characteristics. A disadvantage of bank loans as a source of financing is that the bank may seek a measure of protection against default by the borrower via extensive financial covenants. Through securities, capital is provided by investors who purchase the securities upon their initial issuance. In a similar way, a government may issue securities when it chooses to increase government debt.

Debt and equity

Securities are traditionally divided into debt securities and equities.

Debt

Debt securities may be called debentures, bonds, deposits, notes or commercial paper depending on their maturity, collateral and other characteristics. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities may be protected by collateral or may be unsecured, and, if they are unsecured, may be contractually "senior" to other unsecured debt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that is not senior is "subordinated".
Corporate bonds represent the debt of commercial or industrial entities. Debentures have a long maturity, typically at least ten years, whereas notes have a shorter maturity. Commercial paper is a simple form of debt security that essentially represents a post-dated cheque with a maturity of not more than 270 days.
Money market instruments are short term debt instruments that may have characteristics of deposit accounts, such as certificates of deposit, Accelerated Return Notes, and certain bills of exchange. They are highly liquid and are sometimes referred to as "near cash". Commercial paper is also often highly liquid.
Euro debt securities are securities issued internationally outside their domestic market in a denomination different from that of the issuer's domicile. They include eurobonds and euronotes. Eurobonds are characteristically underwritten, and not secured, and interest is paid gross. A euronote may take the form of euro-commercial paper or euro-certificates of deposit.
Government bonds are medium or long term debt securities issued by sovereign governments or their agencies. Typically they carry a lower rate of interest than corporate bonds, and serve as a source of finance for governments. U.S. federal government bonds are called treasuries. Because of their liquidity and perceived low risk, treasuries are used to manage the money supply in the open market operations of non-US central banks.
Sub-sovereign government bonds, known in the U.S. as municipal bonds, represent the debt of state, provincial, territorial, municipal or other governmental units other than sovereign governments.
Supranational bonds represent the debt of international organizations such as the World Bank, the International Monetary Fund, regional multilateral development banks like the African Development Bank and the Asian Development Bank, and others.

Equity

An equity security is a share of equity interest in an entity such as the capital stock of a company, trust or partnership. The most common form of equity interest is common stock, although preferred equity is also a form of capital stock. The holder of an equity is a shareholder, owning a share, or fractional part of the issuer. Unlike debt securities, which typically require regular payments to the holder, equity securities are not entitled to any payment. In bankruptcy, they share only in the residual interest of the issuer after all obligations have been paid out to creditors. However, equity generally entitles the holder to a pro rata portion of control of the company, meaning that a holder of a majority of the equity is usually entitled to control the issuer. Equity also enjoys the right to profits and capital gain, whereas holders of debt securities receive only interest and repayment of principal regardless of how well the issuer performs financially. Furthermore, debt securities do not have voting rights outside of bankruptcy. In other words, equity holders are entitled to the "upside" of the business and to control the business.

Hybrid

Hybrid securities combine some of the characteristics of both debt and equity securities.
Preference shares form an intermediate class of security between equities and debt. If the issuer is liquidated, preference shareholders have the right to receive interest or a return of capital prior to ordinary shareholders. However, from a legal perspective, preference shares are capital stocks and therefore may entitle the holders to some degree of control depending on whether they carry voting rights.
Convertibles are bonds or preferred stocks that can be converted, at the election of the holder of the convertibles, into the ordinary shares of the issuing company. The convertibility, however, may be forced if the convertible is a callable bond, and the issuer calls the bond. The bondholder has about one month to convert it, or the company will call the bond by giving the holder the call price, which may be less than the value of the converted stock. This is referred to as a forced conversion.
Equity warrants are options issued by the company that allow the holder of the warrant to purchase a specific number of shares at a specified price within a specified time. They are often issued together with bonds or existing equities, and are, sometimes, detachable from them and separately tradeable. When the holder of the warrant exercises it, he pays the money directly to the company, and the company issues new shares to the holder.
Warrants, like other convertible securities, increases the number of shares outstanding, and are always accounted for in financial reports as fully diluted earnings per share, which assumes that all warrants and convertibles will be exercised.

Classification

Securities may be classified according to many categories or classification systems:
Investors in securities may be retail, i.e., members of the public investing personally, other than by way of business.
In distinction, the greatest part of investment in terms of volume, is wholesale, i.e., by financial institutions acting on their own account, or on behalf of clients.
Important institutional investors include investment banks, insurance companies, pension funds and other managed funds.
The "wholesaler" is typically an underwriter or a broker-dealer who trades with other broker-dealers, rather than with the retail investor.
This distinction carries over to banking; compare Retail banking and Wholesale banking.

Investment

The traditional economic function of the purchase of securities is investment, with the view to receiving income or achieving capital gain. Debt securities generally offer a higher rate of interest than bank deposits, and equities may offer the prospect of capital growth. Equity investment may also offer control of the business of the issuer. Debt holdings may also offer some measure of control to the investor if the company is a fledgling start-up or an old giant undergoing restructuring. In these cases, if interest payments are missed, the creditors may take control of the company and liquidate it to recover some of their investment.