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Before understanding, what is security in the stock market? We need to know what a financial instrument is. (Why? You’ll soon realize this while reading the article)
So, a financial instrument is a tradable financial asset which means a financial instrument has monetary value and it can be traded among parties. For example, shares of a company are a financial instrument; you can buy and sell them i.e. trade them and shares also have a monetary value.
What is Security?
You have got to know about Financial instruments. Now, let’s focus on what is security?
Security is a type of financial instrument which means security is also a tradable financial asset. Then how will we know, which financial instrument is security?
We can list down the various financial instruments and here it is:
- Forex market instruments
If you want to know, which among the above list are the securities; just answer the question, ‘which of the financial instruments are traded on a stock exchange?’
A stock exchange facilitates the trading of stocks, debts, and derivatives, period.
What are different types of Securities?
There are 4 types of securities:
- Equity securities
- Debt securities
- Hybrid securities
- Derivative securities
1. Equity Securities
Equity securities are nothing but the stocks themselves. Stocks represent part ownership by an individual in any company or a share in a company. The shares which are bought and sold in the stock market, are equity securities.
Look at it in this way. If you have shares of any company, you’ve equity securities of that company.
Now, you know what equity securities are. Let us understand the features of equity securities i.e. of shares.
How do investors or traders, earn money by the trading of shares?
One way is by capital appreciation which means if you buy a share at Rs.100 and tomorrow if it hits Rs.120 and you decide to sell that share at Rs.120, your capital gain would be Rs.20 per share.
The other way to earn money from shares is through dividend income. Companies give dividends to their shareholders as a reward for their trust in the company. A company is liable to pay a fixed dividend to its preference shareholders but not to its equity shareholders.
By buying or selling shares directly from the market, you’re investing in equity securities but what when you invest in the market through mutual funds? You’re still investing in the shares of the company but indirectly, therefore mutual funds are also considered equity securities.
2. Debt Securities
When a company issues shares i.e. equity securities, it gives you its shares in return for your money and by owning shares you become the part-owner of the company too.
But when companies issue debt securities to raise capital from the market, they don’t give you any shares but return your money with a fixed interest after a specific time (i.e. maturity period). The only perks of investing in debt securities are risk-free, fixed income.
Examples of debt securities are…
- Government & Corporate Bonds
- Certificate of Deposits
- Commercial Papers
- Treasury Bills
- Promissory Notes
- Repurchase Agreements
3. Hybrid Securities
Hybrid securities are securities that combine the characteristics of both equity securities and debt securities.
Equity securities assure your ownership in the company and debt securities give you fixed income either periodically or after a maturity period.
Now, let’s know what are the different examples of hybrid securities and then we’ll get to know how they possess the characteristics of both equity and hybrid securities.
Equity warrants, Convertible bonds and Preference Shares are examples of hybrid securities.
- Equity Warrants:
Equity warrants are instruments that provide the holder of the instrument with the right to buy a particular stock at a predetermined price (strike price) within a specified time frame. However, to gain this right, the buyer of such a warrant is usually required to make any advance payment to the issuer of the warrant.
As a holder of an equity warrant, you can either sell the warrant if the current market price of the stock is higher than the strike price or wait to buy the stock. So, if you don’t decide to sell the warrant(s) you will get ownership of the company after a specific period.
- Convertible Bonds:
A convertible bond is a fixed-income debt security that pays interest but can be converted into a predetermined number of common shares after a specific period.
- Preference Shares:
Preference shares are a type of shares that are preferred over the other equity shares. Holders of preferred stocks possess ownership in the company as well as get the fixed income from the company in the form of fixed dividends.
4. Derivative Securities
A derivative is a financial contract whose value is based on an underlying asset. It means the performance of the underlying asset decides the value of a derivative.
Let’s discuss what are these different underlying assets.
An underlying asset can be a stock, bond, currency, commodity, or market indices like Sensex and nifty.
There are 4 types of derivative contracts:
How Securities are traded?
As you know, the regulatory body of the Indian stock market is SEBI. It means that the stock market in India is bound by the rules and regulations set up by SEBI and as the result, the Indian stock market behaves as a regulated market.
But, do you know what the OTC market is?
OTC (Over the Counter) markets are unregulated markets that don’t obey the guidelines of SEBI and where the trading of financial instruments occurs directly between the buyer and seller through a dealer i.e. no broker, no stock exchange to interfere in the trading between the traders. So, whenever you hear terms like off-exchange trading and OTC trading interpret them as trading that occurs in OTC markets.
Whatever you have read above, I hope, you can see between the lines and summarize it as that the securities are traded either through exchange trading or off-exchange trading.
Exchange trading of securities means the securities are traded on the stock exchange and there is nothing to surprise about that most securities are traded on the stock exchanges.
Off-exchange trading is quite rear but yeah, it does exist.
Any financial instrument that is traded on the stock exchange is called a Security. And the instruments that are traded on the stock exchange are stocks/shares, bonds & debentures, and derivatives including equity derivatives, currency derivatives, and commodity derivatives.
Security can be traded between multiple parties as you can buy shares from person A and then sell them to person C, considering yourself as a person B.
Hope you got the answer to your question, what is security in the stock market?
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