What Is a Security?

A security is a tradable financial instrument that represents an ownership interest, a creditor relationship, or rights to ownership. Common examples include stocks, bonds, options, and other contracts whose value depends on underlying assets.

How Securities Work

Securities allow issuers (corporations, governments, municipalities) to raise capital and investors to gain exposure to income, growth, or risk-management strategies. In many jurisdictions, public offerings and sales of securities are regulated to protect investors and ensure transparent disclosure.

The Howey Test

An investment can be classified and regulated as a security under the Howey Test if:

• There is an investment of money;
• The investment is in a common enterprise;
• The investor expects a profit;
• Any expected profit comes from the efforts of a third party or promoter.

This broad test means many nontraditional arrangements (including some crypto and token offerings) can be treated as securities.

Types of Securities

Equity Securities

• Represent ownership (e.g., common and preferred stock).
• Common stock: voting rights and potential capital gains; paid after creditors in bankruptcy.
• Preferred stock: fixed dividends and higher priority than common stock; often treated like fixed-income.

Debt Securities

• Represent borrowed money that must be repaid with specified interest and maturity (e.g., government and corporate bonds, certificates of deposit).
• Provide contractual interest and principal repayments; generally do not confer voting rights.
• Can be secured (backed by collateral) or unsecured; priority in bankruptcy varies.

Hybrid Securities

• Combine features of equity and debt (e.g., convertible bonds, warrants, preference shares).
• Offer flexibility: a bond that converts into stock or an equity instrument with debt-like payments.

Derivative Securities

• Contracts whose value derives from an underlying asset (stocks, bonds, commodities, indexes).
• Common forms: call and put options, futures, swaps.
• Used for hedging, speculation, or price discovery.

Asset-Backed Securities

• Pools of income-generating assets (mortgages, loans, leases, credit-card receivables).
• Cash flows from the pool are distributed to investors in tranches with varying risk and return.

How Securities Trade

Primary vs. Secondary Markets

• Primary market: issuer sells newly created securities (e.g., initial public offering or IPO).
• Secondary market: existing securities trade among investors; provides liquidity and price discovery.

Trading Venues

• Exchanges list securities for regulated, centralized trading.
• Over-the-counter (OTC) and electronic trading systems enable decentralized trading, especially for less liquid instruments.
• Private placements sell securities to a restricted group of qualified investors and are subject to different regulatory rules.

Clearing and Registration

• Modern markets use electronic recordkeeping and central depositories (e.g., book-entry systems) to hold and transfer securities efficiently.
• Transfer agents and registries track ownership of registered securities.

Investing in Securities

• Investors buy securities to seek income, growth, or portfolio diversification.
• Purchasing on margin means borrowing to buy securities, increasing both potential gains and losses.
• Issuers may use securities instead of loans to raise capital; contractual arrangements can include collateral or covenants.

Residual Securities and Dilution

• Residual or convertible securities (e.g., convertible bonds, convertible preferred) can convert into common stock.
• Conversion increases outstanding shares, which can dilute existing shareholders’ ownership and affect metrics like earnings per share.
• Corporations may consolidate or perform reverse splits to reduce outstanding shares and adjust per-share metrics.

Regulation

• Securities markets are typically regulated by national authorities (e.g., the U.S. Securities and Exchange Commission) to require disclosure, prevent fraud, and maintain fair markets.
• Self-regulatory organizations (SROs) within the brokerage industry (e.g., FINRA) also establish rules and oversee member conduct.

Other Categories and Terms

Certificated vs. Uncertificated

• Certificated securities are represented by physical paper certificates.
• Most modern securities are uncertificated (book-entry) with ownership recorded electronically; rights are the same either way.

Bearer Securities

• Bearer securities confer rights to whoever physically holds the certificate.
• Rare today and often restricted because they can facilitate anonymity and tax evasion.

Registered Securities

• Registered securities record the owner’s name with the issuer and require formal transfer procedures.

Restricted or Letter Securities

• Sold privately and not registered for public resale; transfers typically require issuer consents or adherence to regulatory holding periods.

Cabinet Securities

• Listed but inactive instruments historically held off the trading floor; less relevant in modern electronic markets.

Examples of Issuing Securities

• Startup raises capital: private placement (limited investors) vs. IPO (public investors). IPOs raise more capital but involve greater disclosure and costs.
• Government financing: issues bonds (debt securities) to fund projects, paying periodic coupons to bondholders.
• Convertible financing: startups issue convertible notes (debt initially) that convert into equity at a later financing round—an example of a hybrid security.

Common Questions

What’s the difference between stocks and securities?

Stocks (equity shares) are one type of security. “Securities” is a broader term that also includes bonds, derivatives, asset-backed instruments, and other tradable financial contracts.

What are marketable securities?

Marketable securities are easily bought or sold on public exchanges or active secondary markets (e.g., publicly traded stocks, treasury bonds). Non-marketable securities cannot be freely sold to the public.

What are treasury securities?

Treasury securities are debt instruments issued by a government’s treasury (e.g., U.S. Treasury bills, notes, bonds). They are generally considered low-risk because they are backed by the issuing government.

The Bottom Line

Securities are the primary tools for raising capital and allocating risk across investors and institutions. They come in many forms—equity, debt, hybrids, derivatives, and asset-backed instruments—and trade in primary and secondary markets under regulatory frameworks designed to protect investors and ensure transparent markets. Understanding the type, rights, risks, and market mechanics of a security is essential for making informed investment and financing decisions.