Stocks, Bonds, and Financial Securities Explained

Published: 12/21/2022

What Is a Financial Security?

A financial security is a document representing a legal agreement involving any kind of monetary value. It can be a certificate of ownership or any other item that gives the owner or holder the right to receive something of value, such as cash, goods, or services.

The most common financial security is a stock certificate, which represents ownership in a corporation. Other types of securities include bonds, options and derivatives.

Types of Financial Securities

Equity securities, debt securities, derivatives, asset-backed, and hybrid securities. A financial security is a tradable financial asset. The term often refers to negotiable instruments such as stocks, bonds, and warrants. In some jurisdictions the term specifically excludes financial instruments other than equities and fixed income products.

Equity Securities

Stocks are fractional ownership of a business. You can think of them as little pieces of a company you can own and trade. A stock is a claim on the company's assets and earnings, so when the company does well, so do its shareholders.

A stock has no maturity date like a bond does, but it's not quite as liquid as cash either. If you want to sell your shares before they mature or pay off, you may have to wait until there's an active market for that particular stock — i.e., someone willing to buy it from you at a price that works for both of you.

Debt Securities

Debt Securities include bonds and certificates of deposits (CDs).

Bonds are debt securities issued by governments, companies, and other entities. They're typically bought and sold in the secondary market. Bonds pay a fixed interest rate on a periodic basis until they mature. Interest payments can be made in cash or by issuing more bonds. The value of a bond rises and falls depending on prevailing interest rates and the creditworthiness of the issuer.

Certificates of Deposit (CDs) are time deposits with banks that have fixed terms ranging from three months to five years. They pay a fixed interest rate over their term, which means you know exactly how much you'll get back at maturity without having to worry about fluctuations in stock prices.

Derivative Securities

Derivative Securities are financial instruments that derive their value from the underlying price of an asset. The most common derivative securities are futures, forwards, options and swaps. Futures and forwards are traded on exchanges and OTC (over the counter). An option is a contract that gives an investor the right to buy or sell a security at a specific price on or before a given date. A swap is an agreement in which two counterparties exchange cash flows based on some agreed-upon benchmark or index.

Asset-Backed Securities

Asset-backed securities (ABSs) are complicated financial products that pool together a variety of assets and issue bonds backed by those assets. They can be used to raise money for almost anything, from mortgages to credit card debt. These ABSs can be used as collateral for loans or leases from banks or other lenders. When someone takes out an ABS loan or lease, the lender uses their security as collateral for the loan. If the borrower misses payments on their loan or lease payments, then the lender can sell this security to get their money back.

• Loans

• Leases

• Credit Card Balances

Hybrid Securities

Hybrid securities are financial instruments that combine features of different types of securities. The most common type of hybrid security is convertible bonds, where a bond can be converted into shares at the option of the holder.

Hybrid securities are also known as convertible debt or convertible preferred stock.

Preferred stock is a hybrid security because it combines elements of both debt and equity.

Convertible bonds are also called "convertible preferred" because they have characteristics similar to those of preferred stock. In addition, convertibles pay interest like corporate bonds and can be sold like corporate stocks — making them hybrids between corporate bonds and corporate stocks.

• Preferred stock

• Convertible bonds

Is a Stock a Type of Financial Security or an Investment?

Stocks are essentially agreements that are represented by paper coupons. The actual investment is the portion of a company that you are buying.

The simplest way to explain this would be to compare it with a coupon for a product. For example, if you go to the store and buy 4 cans of soup, you are paying for 4 cans of soup, but you also get a coupon for a free can of soup. The coupon is not the product itself; it's just something that allows you to get another free can of soup sometime in the future.

The same thing goes for stocks. When you buy shares of stock in a company, you're not actually buying anything physical; what you're actually doing is buying part ownership in that company. You don't have any control over how the company operates — all you have control over is how much money gets distributed each year via dividends (if any).

Because there are so many different kinds of companies out there and because their business models can vary wildly from one another, it's impossible to say what kind of return on investment (ROI) you'll receive from investing in stocks overall.

End of Lesson 3

A financial security is a document representing a legal agreement involving any kind of monetary value. Those who possess securities can sell them to others, usually on the stock market, but they can also be used as collateral for loans or traded in foreign exchange markets.

Financial securities are typically categorized into two main types: stocks (also known as equities) and bonds (also known as debt). Stocks give the holder ownership rights to an actual share of a company, while bonds are simply debts due to the issuer of a bond. Both stocks and bonds can be sold in the secondary market at any time before maturity.