What are financial securities?

Ross McGee
Ross McGee

Financial securities are tradable financial instruments which possess value. Despite their name, risk is an integral part of financial securities. In fact, by their very nature, some financial securities are more prone to volatility at varying levels depending upon external factors.

What are financial securities?

There are endless amounts of financial instruments but only some of them are financial securities. Here are some examples of investment vehicles which are classified as securities:

Equity securities

With an equity, an individual or company owns shares of an organisation. As such, it is common for equity owners to have the ability to vote regarding corporate decisions. Depending on whether a growth or income equity is held, respectively the owner will either receive one payment upon selling, or multiple ones over a period of time along with when they sell.

Debt securities

Corporations and governments both tend to issue debt securities for investors. This involves investors lending money to the aforementioned parties, usually in the form of a bond or treasury note. Along with returning the initial total which was lent once the term is over, the borrower must also pay interest at regular intervals throughout. This is often referred to as an interest payment or coupon payment.

In contrast to an equity stock which allows an investor to own a part of a company, a debt security does not. As a result, the likes of bonds do not give investors the right to vote on corporate decisions. However, bonds tend to be safer due to firms always having to repay at least the initial total unless they default.

Hybrid securities

When people invest in a company, along with monetary gain, they also seek control. Hybrid securities offer this to a high degree because they give investors the ability to choose if they would like to switch their debt security into an equity security. For example, with a hybrid security such as a convertible bond, an investor could decide to transform their bonds into shares.

Another example of a hybrid security is an equity warrant or ‘option to buy’. Companies issue these to shareholders, giving them the right to purchase stock at a particular price after a specific period or when a certain event occurs. Again, this allows a high degree of control.

Derivative securities

A derivative is a type of financial contract relating to an underlying asset. As they are not directly connected to a company, investors in derivatives have no voting rights within corporations and don’t own the related underlying asset. Instead, investors with derivatives take a position either against or for an underlying asset. For example, somebody could purchase a call option in the belief that the stock price of Apple Inc. will increase in the next two months. Once this time has passed, they will then have the option to purchase their stock in Apple Inc. at the price agreed when the option was purchased.

Additional securities

With trading being a foundational activity of the economy, what can be traded over the counter (OTC) is extremely vast. As a result, beyond the common types of securities, there are also the likes of:

Certified securities

Ownership of a security through a physical paper is known as a certified security. Despite the additional use of paper, certified securities don’t have any further rights compared to uncertified securities. Nowadays, technology has made paper scarce and as a result this additional part of a security redundant. 

Bearer securities

When ownership of a security is not documented in any form, they are commonly bearer securities. This is because whoever bears (physically possesses) the security is believed to be the rightful owner.

Registered securities

To keep track of who has ownership of securities, issuers employ registers. Within these, the names of security holders and other details are stored. When securities are documented this way, they are known as registered securities.

How are financial securities secured?

Understandably, people who own financial securities aim to keep them safe until they wish to trade them. How easy this is depends on the form of security. For instance, processes such as securities, positions and trades reconciliation are in place to protect equity securities, but when it comes to bearer securities, their ownership hinges solely on physical protection. 

Securities, positions and trades reconciliation

Nowadays, most securities are issued digitally. As a result, bearer securities are a rarity, and securities, positions and trades reconciliation is one of the most conducive ways to ensure that financial securities are allocated to the right place.

This form of reconciliation is founded upon ensuring that when a trade takes place, securities are properly accounted for and held by the correct parties. To conduct this process optimally, it is best to enforce it with financial controls such as automated reconciliation software. This will guarantee the reconciliation of high volumes of high-value transactions takes place with no errors in a timely manner which is compliant with regulations such as MiFID II.

Moreover, regular reconciliation is a vital procedure to guarantee that investors’ money is safe. For example, doing so allows financial management firms to give evidence that their money is rightly held separately from those of investors.

Who regulates securities?

Whilst it is in the best interest of security owners to keep their assets safe, this doesn’t mean that everyone thinks the same. As such, there are various bodies across the globe which impose regulations to safeguard securities.

For example, in the UK there is the Financial Conduct Authority (FCA), in America, there is the Securities and Exchange Commission (SEC), in the European Union, there is the European Securities and Markets Authority (ESMA), and in Australia, there is the Australian Securities and Investments Commission (ASIC). Unsurprisingly, they have very similar rules.

Ross McGee
Ross McGee

Content and Community Marketing Manager

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Ross McGee is a marketing manager at Aurum Solutions who deep dives into financial processes, technology, and best practices to share insights that help finance professionals of all levels maximise their potential.

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