Security types (2024)

What are the types of security?

There are four main types of securities: debt securities, equities, derivatives and hybrid securities, which are a combination of debt and equity.

Let's define security first. A security refers to a financial instrument or asset that can be traded on the open market, for example a share, bond, option contract or shares in ainvestment associationetc. All examples mentioned belong to a certain class or type of effect.

Debt securities

Debt securities or fixed income securities represent money that has been borrowed and that must be repaid under terms that specify the amount borrowed, the interest rate, and the maturity date. In other words, promissory notes are debt instruments, such as bonds (for example, a government or municipal bond) or acertificate of deposit (CD), which can be traded between parties.

Debt securities, such as bonds and certificates of deposit, generally require the holder to make regular interest payments and principal payments, in addition to any other contractual rights. Such securities are usually issued for a specified period of time and eventually the issuer pays them back.

A debt guaranteeinterestThe security of a debt guarantee is determined based on the borrower's credit history, track record and solvency: the ability to repay the loan in the future. The greater the risk that the borrower will default on the loan, the higher the interest rate that a lender will charge to compensate for the risk taken.

It is important to note that the dollar value of daily turnover of debt securities is significantly greater than that of equities. The reason is that debt securities are largely owned by institutional investors, along with governments and non-profit organizations.

Shares

Stocks represent shares of ownership held by shareholders in a company. In other words: becoming a shareholder of the organization is an investment in the share capital of an organization.

The difference between shareholders and bondholders is that the former are not entitled to a regular payment, but can benefit from itcapital gainsby selling the shares. Another difference is that securities give ownership rights to the holder, so that he becomes one of the owners of the company and owns a share in proportion to the number of shares acquired.

In the event that a company goes bankrupt, the capital owners can only share the residual interest left after all debts owed to the bondholders have been paid. Companies regularly pay dividends to shareholders who share in the profits generated from their core activities, while this is not the case for debt holders.

Derivative effects

Derivatives are financial instruments whose value depends on fundamental variables. The variables can be assets such as stocks, bonds, currencies, interest rates, market indices and commodities. The main purpose of using derivatives is to consider and minimize risks. This is achieved by insuring against price fluctuations, creating favorable conditions for speculation and gaining access to hard-to-reach assets or markets.

In the past, derivatives were used to ensure balanced exchange rates for internationally traded goods. International traders needed an accounting system to link their various national currencies to a specific exchange rate.

There are four main types of derivatives:

1. Futures

Futures, also called futures contracts, are an agreement between two parties for the purchase and delivery of an asset at an agreed price at a future time. Futures are traded on an exchange where the contracts are already standardized. In a futures transaction, the parties involved must buy or sell the underlying asset.

2. Extenders

Forward or futures contracts are similar to futures, but are not traded on an exchange, but only at retail. When creating a futures contract, the buyer and seller must determine the terms, amount, and settlement process for the derivative.

Another difference with futures is the risk for both sellers and buyers. The risks arise when one party goes bankrupt and the other party may be unable to protect its rights and, as a result, lose the value of its position.

3. Options

Options or options contracts are similar to a futures contract in that they involve the purchase or sale of an asset between two parties on a predetermined date in the future at a specified price. The main difference between the two types of contracts is that with an option the buyer is not obligated to complete the purchase or sale action.

4. Exchanges

Swaps involve exchanging one form of cash flow for another. For example, ainterest rate swapallows a trader to switch from a fixed rate loan to a variable rate loan, or vice versa.

Hybrid securities

Hybrid security, as the name suggests, is a type of security that combines the features of both debt and equity securities. Many banks and organizations are turning to hybrid securities to borrow money from investors.

Like bonds, they typically promise to pay a higher interest rate at a fixed or variable rate until a certain point in the future. Unlike bonds, the number and timing of interest payments are not guaranteed. They can even be converted into shares, or an investment can be withdrawn at any time.

Examples of hybrid securities include preferred stock that allows the holder to receive dividends before common stock owners, convertible bonds that can be converted into a known number of shares during the life of the bond or at maturity, depending on the terms. of the contract, etc.

Hybrid securities are complex products. Even experienced investors can find it difficult to understand and assess the risks associated with trading with them. Institutional investors sometimes do not understand the terms of the deal they are entering into when purchasing hybrid securities.

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