A security is a financial instrument that is both fungible and negotiable. It is a legal contract that represents the rights of ownership of either some portion of a publicly-traded company, some quantity of credit to a business or government body, some quantity of physical good or commodity, or a derivative instrument.
Equity and Debt
Securities are broadly categorized into either debts or equities.
Debt securities are representative of quantities of money that have been borrowed and need to be repaid at some point in the future according to the terms of the security.
Debt securities usually also carry terms for the payment of interest on the loan, which includes a set time and quantity for interest payments. Debt securities are also defined by the rights to collateral or assets that can be exercised in the event of a failure to meet the terms of the security.
Equity securities represent a share of ownership of a company and a right to a share of the proceeds of that company, if any. Equity securities generally confer some degree of control over the company through shareholders’ voting rights.
Equity securities only entitle the owner to a pro rata share of whatever assets remain after all creditors of the company have been paid.
There are now also a number of hybrid securities that offer some novel and synthetic combination of the above general features. While these hybrid securities may still be rare in comparison to the traditional sort, they are growing rapidly in number and influence.
The Purpose of a Security
A security is a means of investment and capital-raising, acting as a contract between the issuer and the investor. Securities are issued as an alternative to the traditional financing route of seeking a commercial loan from a bank, when the cost of raising capital through the former is lower than through the latter.
Securities allow borrowers to raise capital on very specific terms that are best suited to their needs, ability to repay and willingness to surrender control of their organization.
Every security represents a unique blend of quantity borrowed, terms of repayment and ownership conferred, unlike a bank loan that represents a generally standard term for repayment and liquidation in the event of default.
By choosing the precise combination of terms for their issued securities, borrowers can often achieve far superior results when compared to a traditional bank loan.
As a central element in a modern capitalist economy, securities have long been regulated by both criminal and civil authorities.
Unregulated securities are prone to fraud and other abuses, which lower the level of trust in capital markets and, in turn, increases the overall cost of capital for organizations.
Governments have a strong incentive to ensure the safe and orderly conduct of their capital markets, which means that the creation, distribution and resale of all securities are heavily regulated and controlled by a variety of civil and criminal enforcement bodies.
In America, the civil regulation of security issuance and trading is overseen by the Securities and Exchange Commission (SEC). The SEC creates the rules for the issuance and resale of securities, and hands out civil penalties for infractions.
Criminal investigations generally fall under the mandate of the local police services for intra-state financial crimes and the Federal Bureau of Investigation (FBI) for inter-state financial crimes.
Securities and Trading
Almost every trade that a day trader makes will involve a security of some sort, the general exception being currency trading, though currency trading also features a large number of securities in the form of options.
It is important for traders to understand the often highly complex relationship that a security represents. While many day traders will only ever trade in traditional equity shares, which all feature a standard boiler-plate set of agreements, even contemporary equity markets are filled with exceptions that represent more complex systems of ownership and repayment.
The value of a security is heavily dependent on the precise terms that it entails. While the capital markets may still currently be dominated by traditional boiler-plate securities with clear terms of ownership and repayment, many securities represent highly complex arrangements, many features of which only become activated in the event of a default or liquidation.
Traders should be extremely careful to always fully understand the terms of any security that they intend to trade.