IIBF LEGAL ASPECTS OF BANKING OPERATIONS VARIOUS TYPES OF SECURITIES

IIBF LEGAL ASPECTS OF BANKING OPERATIONS | VARIOUS TYPES OF SECURITIES

SECURITY

A financial asset that holds a monetary value and it represents ownership of financial assets such as stocks, shares, bonds, and options. Although the popular securities that most people know of are equities and debentures. There is also a third category which is a blend of debt and equity. 

TYPES OF SECURITIES

These securities can be categorized into 3 types which are discussed below:

EQUITY SECURITIES: 

Stocks and shares are referred to as equity which represents shareholders’ ownership of the company. Shareholders on their income in the form of dividends on the equity shares. Equity shares which are listed on stock exchanges are volatile and their prices keep changing as per the conditions of the market. 

The interest of ownership is represented through equity securities in a company. In other words, it is a kind of investment in the equity stock of an organization. 

Holders of equity securities a not entitled to a regular payment. They earn from the prophets that happen from capital gains on selling the stocks. Other than the capital gains, they also get ownership rights as they become the owners of the company having a proportionate take as per the number of shares they have purchased.

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In case a business has to face bankruptcy, holders of equity share the residual interest which remains after meeting or paying all the obligations to the outside creditors of the business. 

Companies that are earning well also distribute their profits in the form of dividends to the shareholders. 

The Equity Securities can be categorized into the below 2 categories:

Common Shares: These shares simply represent the ownership of the shareholder, a claim over earnings & net assets on liquidation along with the voting power that enables them to vote in decisions of the company. 

Preferred Shares: Preferred shares get preference over common shares in terms of the company’s earnings or dividends & assets during the liquidation.

DEBT SECURITIES: 

These instruments are just like Government Bonds, corporate bonds, certificates of deposits, treasury bills, etc. These securities are issued with the promise that the amount of the Bond will be repaid along with the interest. 

When a company issues bonds, the interest rate, borrowed amount, and the animal as well as the maturity dates are pre-determined. 

Debt is fixed-income security which he presents The Mount that has been borrowed and must prepay as per the terms of the issue. In simple words, these are debt instruments (Bonds or Certificates of Deposit) that can be traded between parties.

They require the issuer to make regular payments of interest and then we pay the principal amount as per the contractual terms that have been proposed when they were issued. They are issued for a fixed term and on the date of maturity, they are redeemed by repaying the principal and premium (if any) amount.

What is important to note is bad been that securities are traded more than the stocks on daily basis. The reason behind this is that the institutional investors (as well as Government and not-for-profit organizations) hold these debt securities on a large scale than the equities.

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DERIVATIVES: 

They are the kind of investment securities that drive their value from the underlying assets. It is a kind of contract between two or more parties wherein it is agreed that the value of an investment will be based on the underlying asset. 

Their value depends on some of the basic factors such as bonds, currencies, interest rates, stocks, market indices as well as goods (commodities). Derivatives are mainly traded to reduce the risk. The action is achieved by insuring against the price movements, thus creating favorable conditions for speculations. 

Derivative having used to balance we exchange rates for goods that have been traded internationally. 

Derivatives have four main types of securities which are discussed below:

1. Futures: Futures are also termed as futures contracts which are basically an agreement between two parties to purchase & deliver an asset at a future date at an agreed-upon price. Futures are also traded on exchanges. Their contracts are already standardized and while doing a futures transaction, the parties involved must buy or sell the underlying asset.

2. Forwards: Forward contracts or simply referred to as ‘Forwards’ are similar to futures, but they do not get traded on any exchange. The transactions in forwards happen on OTC (Over the counter). When entering into a forward contract, the buyer & seller have to decide the terms of the contract, the lot size/amount of the underlying, and how the contract will be settled for the derivative.

Another difference between futures & forward is the risk that both sellers and buyers bear. This is the risk of one party becoming bankrupt, while the other party might not be able to protect its rights and, therefore, will lose the value of its position.

3. Options

Options contracts or sometimes referred to just as options are similar to a futures contract because it involves the purchase or sale of an asset between two parties at a predetermined future date for a specific price that is already agreed between the parties. Future & Options are different in the way that the buyer is not required to actually complete the action of buying or selling.

4. Swaps

Swaps as the term indicate involve an exchange of one kind of cash flow with another. For instance, if you buy an interest rate swap, it will enable you to switch to a fixed interest rate loan from a variable interest rate loan or vice versa.

The underlying financial instruments of Swaps mostly are commodities, bonds, currencies, stocks, etc.

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TAX-FREE GOVERNMENT SECURITIES

The main feature of Tax-free Government Securities is that the income generated from them is tax-exempt. This way, the returns (earnings) of investment are done in tax-free govt. securities are free from local & state taxes.

These investments are available to be bought in the form of bonds. These are backed by Government or Government bodies & the other characteristics of these (tax-free govt. securities) are:

• They have longer tenure =/>10 years;
• They also have a specified lock-in period (under this period, one can’t trade i.e sell off these in the market), and 
• They usually bear fixed interest rates.
• An example of tax-free government security in India is Municipal bonds.

SECURITIES MARKET vs. STOCK MARKET

The securities market is a part of the financial market where securities are traded. Insecurities market includes the equity market, derivative market & bond market. Traditionally, the securities market has been used to attract new capital.

It does not have a specified place where securities are traded. The trading happens over the counter (OTC) offline. The period of the term of investment is longer in the securities market.

The stock market while on the other hand includes only tradable shares of the listed companies. The shares can be either equity or preference shares. A stock market is a central place where shares can be bought and sold.