Types of Security in Financial Markets

Types of security refers to wide range of financial instruments from stocks, ETFs, and bond. It is chosen depending on the financial and legal situations. In this article, we will be discussing the different types of security in financial markets and their ROI.

Table of Contents

• What is security?
• Features of Security
• Types of Security

What is security?

A financial instrument that can be traded in the financial market is known as security. It is a financial asset holding a value and it can be traded, bought, and sold in the financial market. The ROI of security varies according to the jurisdiction in which it is being traded.

When companies want to start selling their stocks in the market, they declare an IPO. The aim is to go public and gain investors. These are the limited sale of shares that are offered at discounted prices. Through the IPO issue, companies transition from having private to public ownership. Both institutional and public investors have the option to buy shares during this IPO stage. 

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Features of Security

The following are the features of securities in the market:

• The seller of different types of security is known as the issuer, whereas the buyer is known as an investor. 
• The types of security traded in the financial market are fungible in nature. It means that assets are exchangeable and can be replaced with the stock of another company having the same amount. 
• Securities are regulated by regulatory agencies such as SEBI in India and SEC in the U.S. Securities are traded in the market as per the regulations of these bodies.
• Securities holders make profits in the market through capital gains by selling stocks. 
• Companies and organizations can raise funds by declaring an IPO to trade securities in the open market. 

Types of Security

Broadly, all traded financial assets are known as securities. There are mainly four types of security in financial markets: 

1. Equity

This type of security indicates the amount of money that a company owes to its shareholders. Equity is a type of security is listed on the balance sheet of the company. Analysts use the information related to equity to assess the financial health of a company. It represents the value that would be returned to its shareholders in case all of its assets are liquidated and debts are paid off. 

This equity represents the book value and pro-rata ownership of the company’s shares. Anyone having company equity has a share in the company. This type of security is classified based on single assets, book value, business entity and market value. The increase and decrease in value based on the performance of the company and financial markets. The following equation helps in calculating equity:

Shareholders’ Equity = Total (Assets − Liabilities)

2. Derivatives

Derivatives are one of the different types of security since their value is based on underlying assets. These complex financial instruments are used for hedging and gaining assets to markets and additional assets. Derivatives are traded over-the-counter (OTC) that are traded on a specialized exchanges. 

In the trading of derivative securities, both parties that are involved in betting on the value of underlying assets change in opposite ways. Futures contract is a type of derivatives security. It is an agreement to buy and sell an asset at the predetermined future date for a set price. 

3. Debt Securities

These are fixed income securities that are utilised by the government and organizations for raising money. For this purpose, they use publicly traded loans in exchange for regular payments of interest along with the repayment of the principal loan. The investor becomes the lender and the issuer becomes the borrower in the case of debt securities. 

These are issued by companies, individuals, and the government for a certain amount and are sold to other parties for a certain amount. They have a specified rate of interest and come with a maturity date. Bank notes, bonds, and treasury bills are examples of debt securities.

4. Hybrid Securities

These are a type of security that consists of the element of two or more financial instruments. Also known as hybrids, they combine the characteristics of both debt and equity. One of the common types of securities in the hybrid category is convertible bonds. It consists of the features of an ordinary bond but is also influenced by the stock price movement.

These are bought and sold either on exchange or brokerage. Such securities provide investors with a fixed or floating rate of return. It may pay returns on investments in the form of dividends. This security type is viewed as esoteric debt and is often difficult to sell due to its complexity. Convertible preference shares pay dividends at a fixed rate or floating rate before common dividends are paid. These can be exchanged for the shares of an underlying stock of the company.