What is a Security?

Securuites

What is a Security?

You may have heard the terms Stocks, Bonds, ETFs, Commodities, Assets, etc. but do you you know what a Security is? The financial definition of a security is any securitized piece of paper that can be traded for a value. The financial definition doesn’t provide much clarity in defining a security. Don’t worry YP Investors is here to help. In this article we will define a security and provide the most common types of securities.

What is a Security: Defined

The Securities and Exchange Act of 1934 established the Securities and Exchange Commission (SEC). Under this act allows the SEC to regulate Securities Exchanges to protect Investors like us. This act also helps to define a security. Under the act the a security is any of the following: Stock, Bond, Note, Investment Contract, Debenture, Certificate of Interest in a profit-sharing or partnership agreement, Certificate of Deposit, Collateral Trust Certificate, Preorganization Certificate, Option on a Security, Right or Warrant, or other instrument of investment. We will cover the most common types of securities including Stocks, Bonds, Debentures, Options, and Notes.

Let’s circle back to the original financial definition “any securitized piece of paper that can be traded for value.” This might make more sense now after seeing some examples. It basically means anything that has a certain value and is recorded and can be traded. Every stock you own is recorded electronically. Before the days of online brokers, if you bought a stock you were sent the actual stock certificate in the mail. As you can see there are many of types of securities, so let’s make this easier and define what isn’t a security.

What’s not a security?

Under the Uniform Securities Act the following are not included in the definition of a security: An Insurance/Endowment Policy or Annuity promising to pay a fixed payment (lump sum or periodically), Collectibles, Commodities and Futures Contracts, Condominiums used a Personal Residence, and Currency. This list of non-securities is much shorter than the list of securities, so knowing these makes securities easier to identify.


What is a Security?

Securities are any of the following: Stock, Bond, Note, Investment Contract, Debenture, Certificate of Interest in a profit-sharing or partnership agreement, Certificate of Deposit, Collateral Trust Certificate, Preorganization Certificate, Option on a Security, Right or Warrant, or other instrument of investment.

What is Not a Security?

The following are Not Securities: An Insurance/Endowment Policy or Annuity promising to pay a fixed payment (lump sum or periodically), Collectibles, Commodities and Futures Contracts, Condominiums used a Personal Residence, and Currency.


Common Types of Securities

Stocks

Stocks are the most popular type of security. They are issued by a company and recipient of the stocks pays for them, in return the recipient gets equity (ownership) in the company. There are two types of stocks a company can issue: Common Stock and Preferred Stock. Stock Options are also securities and are rights of ownership to Common Stock.

Common Stock

  • Most widely known (when people invest in stocks they probably mean common stock)
  • Rate of return is Variable: Appreciates with company (the better the company does the higher the stock price)
  • Each stock entitles the holder to a portion of the company including the companies earnings and dividends
  • Each stock holder gets a proportionate vote in major management decisions
  • If the company is liquidated common stock holders are on the bottom of the payout list behind all debt securities (bonds) and also behind preferred stock. Common stock will get what is left after everything is paid off

Preferred Stock

  • Has equity ownership in the company but with limited rights
  • Rate of Return is Fixed: Fixed Dividend (Interest) payment for each preferred stock
  • Has priority of Dividend payment over Common Stock (Must pay all of preferred stock dividends before paying any common stock dividends)
  • No Voting Rights
  • No appreciation (If company does great dividend payments remain the same)
  • If the company is liquidated preferred stockholders are paid off before any common stockholders, but only after all debt securities (bonds) are paid off

Bonds

Bonds are mainly used for Income Investing. The par value of one bond is $1,000 (for almost every bond out there). Bond prices can vary like stock prices, but the interest payment always remains the same. For example if you buy a 6% bond you will get paid $60 a year (6%*$1,000) until expiration. At expiration you will be paid back the par value of $1,000. (If you bought the bond at par you paid $1,000 for it.) Now if the Fed announces it is raising interest rates the price of your bond will probably drop below $1,000 because there are now new bonds available with more than 6% interest rate.

On the contrary if the interest rates drop your bond will be worth more than $1,000 because the demand for your high yield bond is high. Remember if you are holding the bond until expiration you will always get the par value of $1,000 back, but only if the company can afford to pay you back. This is why credit ratings of companies bonds are so important in bond pricing and yields.

There are many different types of bonds, but the main categories are Corporate Bonds and Debentures, US Treasury Bills, Notes, and Bonds, and Municipal Bonds. Each have their own pros and cons and the same philosophy goes with bonds as with stocks. The more risk you are willing to take the more reward you can receive.

Corporate Bonds

Corporate Bonds are secured bonds backed by some asset of the company. Just like the mortgage on your house is backed by the value of your house, a corporate bond can be backed by real estate, equipment, etc. Any Bond is rated based on both the Standard and Poor’s or Moody’s rating system. The higher the rating the better the credit of the issuer and more likely they will pay you back at bond expiration. This means they will typically have lower interest rates because they are safer. If you want a successful investment in bonds you have to make sure the company is sound and headed in the right direction just as with investing in stocks.

Debentures

Debentures are Corporate Bonds but they are unsecured. They are backed only by the companies word and creditworthiness. Although these are unsecured, some companies Debentures can be safer than another companies secured bonds.

US Government Securities

Us Government Bonds are the safest of all securities. The Treasury issues are directly backed by the US government. US Treasury issues include Treasury Bills (T-Bills), Treasury Notes, and Treasury Bonds. One benefit from US Treasury Securities is they are exempt from state taxes. Here are the details for each of these:

Treasury Bills

Short Term debt obligations of the US Government. Similar to bonds but no interest paid

Maturity dates varying from 4 weeks up to 52 weeks

Pay NO Interest but are sold at a discount price. Example: A 13-week T-Bill sold at $990. At maturity in 13 weeks the owner gets paid $1,000 so profit is $10 = 1%.

Treasury Notes

Debt obligations of the US Government. Act the same as bonds, except they are guaranteed

Maturity dates from 2 years up to 10 years

Pay Interest and mature at par value. Interest is paid semi-annually

Treasury Bonds

Debt obligations of the US Government. Act the same as bonds, except they are guaranteed

Maturity dates from 10 years up to 30 years

Pay Interest and mature at par value. Interest is paid semi-annually

Know your Securities

Knowing all the different types of securities and how they work expands your investing knowledge. This in turn will make you a better investor. Think about an investor who only knows stocks vs one who knows both stock and bonds. If they want to use their money to make them money but not lose an of it then US Treasury securities makes more sense than stocks. Yes you probably wont make as much if the stocks pan out, but you definitely will not lose any money.

The more you know in the financial world, the more options and flexibility you have to make money! This is why YP Investors is here, to help you in your financial journey. Make sure to check out all of our Investing Articles and our Stock Analysis Tools based on Point and Figure Charting. Try out these tools for free with a free trial membership today! Good luck on your investments.

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