Securities are financial instruments, contracts that are given a value and then traded. This may be a bond, a mortgage-backed security or a share. In the UK, ‘gilts’ are the equivalent of US Treasury securities.
Put simply, securities are any proof of ownership or debt that have a value and may be sold.
Securities are usually divided into debt securities, equities and derivative contracts:
Debt Security – this represents borrowed money that must be paid back. The arrangement is detailed beforehand, including how much is borrowed, at what interest rate, plus renewal or maturity date.
There are several types of securities.
Examples of debt securities include certificates of deposit (CDs), corporate bonds, government bonds, collateralized securities, and preferred stock.
Equity security – refers to the ownership interest in a company by shareholders, such as shares (stock). Holders of equity securities can profit from capital gains. If the company makes a good profit, the equity security holders share in this gain, unlike holders of debt securities who only receive interest and the repayment of the capital.
Traditionally, companies raise new capital through securities, which offer certain advantages over bank loans.
Derivative contracts – also known simply as ‘derivatives’. They represent a contract between two parties that specify conditions, such as dates, resulting values and definitions of the underlying variables, the contractual obligations of each party, and the notional amount, that the two parties established for making and receiving payments.
Examples of derivatives include options, swaps, futures, forwards, and variations of them such as caps, floors, collars, and credit default swaps.
Most derivatives are marketed through an exchange, such as the Chicago Mercantile Exchange, or off-exchange (over-the-counter).
Security may refer to guarantees on loans
When an individual is taking out a loan, ‘security’ could mean collateral, i.e. an asset that is pledged in case the borrower fails to pay the money back.
In many countries, when people take out a mortgage the loaned money is secured on the borrower’s house. If the borrower is unable to repay the loan, the lender has recourse to seize the home and sell it in order to recover what is owed.
Certified securities are in paper (physical) form. There are two different types:
Bearer securities – these are negotiable financial instruments which contain no information on ownership. The bearer is presumed to be the owner – they can be bought and sold to anyone. However, because of increasing digitization, these securities are becoming rare.
Registered securities – all virtual securities which are traded are registered securities. The owners’ names are recorded by a registrar – the issuer or the issuer’s agent.
U.S. Securities and Exchange Commission
The U.S. Securities and Exchange Commission, often referred to by its acronym SEC, is the U.S. federal agency that makes sure security traders obey the law.
To draw an analogy, it is similar to what the FDA (Food and Drug Administration) is for the pharmaceutical, food and medical device indutries, but focuses on security traders, making sure they are honest and fair and that investors are protected.
The SEC can impose fines, referral for criminal prosecution, and revoke or suspend traders’ licenses.
The SEC writes on its website:
“The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
Some countries have one large agency that covers all financial products. An example is the Financial Services Authority (FSA) in the United Kingdom.
Trade organizations for securities dealers
The main trade organization for securities dealers in the U.S. is the Securities Industry and Financial Markets Association.
Most securities are bought and sold in capital markets. Examples of highly-organized capital markets are NASDAQ, the New York Stock Exchange, and the London Stock Exchange.
Video – What are securities?