Securities as an Instrument to Trade and Invest

A security is a type of financial instrument that can be traded for cash. The three main categories of assets are derivative contracts, equity, and debt securities. They are issued and traded by businesses, corporations, government agencies, and municipal authorities. The majority of investment vehicles are negotiable.

Types of Assets

Companies and individuals invest in different types of debt securities, including debentures, bonds, and banknotes. A debenture is a debt instrument that is not backed by collateral or some valuable asset. The reputation or creditworthiness of the issuing entity serves as a guarantee of payment. National authorities and businesses often issue debentures to raise working capital. There are various types of debentures such as government-issued T-bills and T-bonds, which are considered safe investments. Bonds come in different varieties, including inflation-indexed treasuries, zero coupon bonds, municipal and corporate bonds, and others. Yields can be tax-free or taxable. Corporate bonds are issued by businesses and offer higher yields.

At the same time, they carry a higher risk compared to government bills and bonds. Corporations with a low credit rating often offer junk or high risk bonds. Maturities vary from a couple of weeks to 20 – 100 years, and interest is taxable. There are also equity securities and derivative contracts such as options, rights, common stock, warrants, and others. Warrants, for example, are equity instruments that allow investors to purchase common shares in a future period. Most warrants don’t have an expiry date and sell at a subscription price. Both options and warrants allow investors to purchase securities, but warrants’ prices are higher compared to the value of newly issued company shares. Subscription rights allow stockholders to subscribe to shares before the new stock issue is available for purchase. Rights often have a life of between 2 and 4 weeks, which is the timeframe to exercise them. Investors can trade them much like shares. They expire in case they are not sold or exercised within the specified period.

The major types of equity securities include depository receipts, preference shares, and common shares. Preferred stock is irredeemable in most cases, which is also a characteristic of common stock. Common stockholders are paid only after holders of preferred shares. Moreover, there are different types of preferred or preference shares, including convertible, redeemable, participating, and cumulative. Convertible stock can be exchanged at a specified conversion price. Redemption occurs when a business buys shares back at a specified or at par price. Preferred shares may be cumulative meaning that unpaid dividends are paid out to stockholders in a subsequent accounting period. With cumulative shares, dividends and interest are also paid in subsequent periods. Common stockholders are paid only after preferred stockholders receive all outstanding interest.

Other Types of Derivative Contracts

Investors can choose from different types of derivatives such as swaps, futures, and forwards. A swap is a contract that allows one security to be exchanged for another. There are benefits to this arrangement, and one is building a better investment portfolio. Swaps also take place to change the quality of an issue or the term or maturity. Other types include interest rate and currency swaps. A futures contract is a formal agreement to trade financial instruments and commodities. A forward is also a type of contract used for financial transactions. The delivery of goods and services is deferred until a specified future date. There is a difference between spot and forward contracts in that assets are traded today under a spot agreement.

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