is a fungible, negotiable instrument representing financial
value. Securities are broadly categorized into debt securities,
such as banknotes, bonds and debentures, and equity securities,
e.g. common stocks. The company or other entity issuing the
security is called the issuer. What specifically qualifies as
a security is dependent on the regulatory structure in a country.
For example private investment pools may have some features
of securities, but they may not be registered or regulated as
such if they meet various restrictions.
may be represented by a certificate or, more typically, by an
electronic book entry. Certificates may be bearer, meaning they
entitle the holder to rights under the security merely by holding
the security, or registered, meaning they entitle the holder
to rights only if he or she appears on a security register maintained
by the issuer or an intermediary. They include shares of corporate
stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, limited partnership units,
and various other formal investment instruments that are negotiable
may be classified according to the following categories:
- Tax treatment
Type of Issuer
of securities include commercial companies, government agencies,
local authorities and international and supranational organizations
(such as the World Bank). Debt securities issued by a government
(called government bonds or sovereign bonds) generally carry
a lower interest rate than corporate debt issued by commercial
companies. Interests in an asset -- for example, the flow of
royalty payments from intellectual property-may also be turned
into securities. These repackaged securities resulting from
a securitization are usually issued by a company established
for the purpose of the repackaging-called a special purpose
vehicle (SPV). See "Repackaging" below. SPVs are also used to
issue other kinds of securities. SPVs can also be used to guarantee
securities, such as covered bonds.
Commercial enterprises have traditionally used securities as
a means of raising new capital. Securities may be an attractive
option relative to bank loans depending on their pricing and
market demand for particular characteristics. Another disadvantage
of bank loans as a source of financing is that the bank may
seek a measure of protection against default by the borrower
via extensive financial covenants. Through securities, capital
is provided by investors who purchase the securities upon their
initial issuance. In a similar way, governments may raise capital
through the issuance of securities (see government debt).
In recent decades securities have been issued to repackage existing
assets. In a traditional securitisation, a financial institution
may wish to remove assets from its balance sheet in order to
achieve regulatory capital efficiencies or to accelerate its
receipt of cash flow from the original assets. Alternatively,
an intermediary may wish to make a profit by acquiring financial
assets and repackaging them in a way which makes them more attractive
Type of Holder
in securities may be retail, i.e. members of the public investing
other than by way of business. The greatest part in terms of
volume of investment is wholesale, i.e. by financial institutions
acting on their own account, or on behalf of clients. Important
institutional investors include investment banks, insurance
companies, pension funds and other managed funds.
The traditional economic function of the purchase of securities
is investment, with the view to receiving income and/or achieving
capital gain. Debt securities generally offer a higher rate
of interest than bank deposits, and equities may offer the prospect
of capital growth. Equity investment may also offer control
of the business of the issuer. Debt holdings may also offer
some measure of control to the investor if the company is a
fledgling start-up or an old giant undergoing 'restructuring'.
In these cases, if interest payments are missed, the creditors
may take control of the company and liquidate it to recover
some of their investment.
The last decade has seen an enormous growth in the use of securities
as collateral. Purchasing securities with borrowed money secured
by other securities is called "buying on margin." Where A is
owed a debt or other obligation by B, A may require B to deliver
property rights in securities to A. These property rights enable
A to satisfy its claims in the event that B becomes insolvent.
Collateral arrangements are divided into two broad categories,
namely security interests and outright collateral transfers.
Commonly, commercial banks, investment banks and government
agencies are significant collateral takers.
are traditionally divided into debt securities and equities.
may be called debentures, bonds, deposits, notes or commercial
paper depending on their maturity and certain other characteristics.
The holder of a debt security is typically entitled to the payment
of principal and interest, together with other contractual rights
under the terms of the issue, such as the right to receive certain
information. Debt securities are generally issued for a fixed
term and redeemable by the issuer at the end of that term. Debt
securities may be protected by collateral or may be unsecured,
and, if they are unsecured, may be contractually "senior" to
other unsecured debt meaning their holders would have a priority
in a bankruptcy of the issuer. Debt that is not senior is "subordinated".
bonds represent the debt of commercial or industrial entities.
Debentures have a long maturity, typically at least ten years,
whereas notes have a shorter maturity. Commercial paper is a
simple form of debt security that essentially represents a post-dated
check with a maturity of not more than 270 days.
market instruments are short term debt instruments that
may have characteristics of deposit accounts, such as certificates of deposit, and certain bills
of exchange. They are highly liquid and are sometimes referred
to as "near cash". Commercial paper is also often highly liquid.
debt securities are securities issued internationally outside
their domestic market in a denomination different from that
of the issuer's domicile. They include eurobonds and euronotes.
Eurobonds are characteristically underwritten, and not secured,
and interest is paid gross. A euronote may take the form of
euro-commercial paper (ECP) or euro-certificates of deposit.
bonds are medium or long term debt securities issued by
sovereign governments or their agencies. Typically they carry
a lower rate of interest than corporate bonds, and serve as
a source of finance for governments. U.S. federal government
bonds are called treasuries. Because of their liquidity
and perceived low risk, treasuries are used to manage the money
supply in the open market operations of non-US central banks.
government bonds, known in the U.S. as municipal bonds, represent the debt of state, provincial,
territorial, municipal or other governmental units other than
bonds represent the debt of international
organizations such as the World Bank, the International Monetary
Fund, regional multilateral development banks and others.
security is a share in the capital stock of a company (typically
common stock, although preferred equity is also a form of capital
stock). The holder of an equity is a shareholder, owning a share,
or fractional part of the issuer. Unlike debt securities, which
typically require regular payments (interest) to the holder,
equity securities are not entitled to any payment. In bankruptcy,
they share only in the residual interest of the issuer after
all obligations have been paid out to creditors. However, equity
generally entitles the holder to a pro rata portion of control
of the company, meaning that a holder of a majority of the equity
is usually entitled to control the issuer. Equity also enjoys
the right to profits and capital
gain, whereas holders of debt securities receive only interest
and repayment of principal
regardless of how well the issuer performs financially. Furthermore,
debt securities do not have voting rights outside of bankruptcy.
In other words, equity holders are entitled to the "upside"
of the business and to control the business.Hybrid
combine some of the characteristics of both debt and equity
shares form an intermediate class of security between equities
and debt. If the issuer is liquidated, they carry the right
to receive interest and/or a return of capital in priority to
ordinary shareholders. However, from a legal perspective, they
are capital stock and therefore may entitle holders to some
degree of control depending on whether they contain voting rights.
are bonds or preferred stock which can be converted, at the
election of the holder of the convertibles, into the common
stock of the issuing company. The convertibility, however, may
be forced if the convertible is a callable bond, and the issuer
calls the bond. The bondholder has about 1 month to convert
it, or the company will call the bond by giving the holder the
call price, which may be less than the value of the converted
stock. This is referred to as a forced conversion.
warrants are options issued by the company that allows the
holder of the warrant to purchase a specific number of shares
at a specified price within a specified time. They are often
issued together with bonds or existing equities, and are, sometimes,
detachable from them and separately tradable. When the holder
of the warrant exercises it, he pays the money directly to the
company, and the company issues new shares to holder.
like other convertible securities, increases the number of shares
outstanding, and are always accounted for in financial reports
as fully diluted earnings per share, which assumes that all
warrants and convertibles will be exercised.
and Secondary Market
securities markets can be divided into primary and secondary
markets. The distinguishing difference between the two markets
is that in the primary market, the money for the securities
is received by the issuer of those securities from investors,
whereas in the secondary market, the money goes from one investor
to the other. When a company issues public stock for the first
time, this is called an Initial Public Offering (IPO). A company
can later issue more new shares, or issue shares that have been
previously registered in a shelf registration. These later new
issues are also sold in the primary market, but they are not
considered to be an IPO. Issuers usually retain investment banks
to assist them in administering the IPO, getting SEC (or other
regulatory body) approval, and selling the new issue. When the
investment bank buys the entire new issue from the issuer at
a discount to resell it at a markup, it is called an underwriting,
or firm commitment. However, if the investment bank considers
the risk too great for an underwriting, it may only assent to
a best effort agreement, where the investment bank will simply
do its best to sell the new issue.
for the primary market to thrive, there must be a secondary
market, or aftermarket, where holders of securities can sell
them to other investors for cash, hopefully at a profit. Otherwise,
few people would purchase primary issues, and, thus, companies
and governments would be unable to raise money for their operations.
Organized exchanges constitute the main secondary markets. Many
smaller issues and most debt securities trade in the decentralized,
dealer-based over-the-counter markets.
the principal trade organization for securities dealers is the
International Capital Market Association. In the U.S., the principal
organization for securities dealers is the Securities Industry
and Financial Markets Association. The Bond Market Association
represents bond dealers globally.
Offer and Private Placement
In the primary
markets, securities may be offered to the public in a public
offer. Alternatively, they may be offered privately to a limited
number of qualified persons in a private placement. Often a
combination of the two is used. The distinction between the
two is important to securities regulation and company law. Privately
placed securities are often not publicly tradable and may only
be bought and sold by sophisticated qualified investors. As
a result, the secondary market is not as liquid.
category, sovereign debt, is generally sold by auction to a
specialised class of dealers.
and OTC Dealing
are often listed in a stock exchange, an organized and officially recognized
market on which securities can be bought and sold. Issuers may
seek listings for their securities in order to attract investors,
by ensuring that there is a liquid and regulated market in which
investors will be able to buy and sell securities.
informal electronic trading systems has challenged the traditional
business of stock exchanges. Large volumes of securities are
also bought and sold "over the counter" (OTC). OTC dealing involves
buyers and sellers dealing with each other by telephone or electronically
on the basis of prices that are displayed electronically, usually
by commercial information vendors such as Reuters and Bloomberg.
also eurosecurities, which are securities that are issued outside
their domestic market into more than one jurisdiction. They
are generally listed on the Luxembourg Stock xchange or admitted
to listing in London. The reasons for listing eurobonds
include regulatory and tax considerations, as well as the investment
the centre of the eurosecurities markets. There was a huge rise
in the eurosecurities market in London in the early 1980s. Settlement
of trades in eurosecurities is currently effected through two
European computerised systems called Euroclear (in Belgium)
and Clearstream (formerly Cedelbank) in Luxembourg.
market for Eurobonds is the EuroMTS, owned by Borsa Italiana
Nature of Securities
that are represented by certificates are called certificated
securities. They may be bearer or registered.
are completely negotiable and entitle the holder to the rights
under the security (e.g. to payment if it is a debt security,
and voting if it is an equity security). They are transferred
by delivering the instrument from person to person. In some
cases, transfer is by endorsement, or signing the back of the
instrument, and delivery.
and fiscal authorities sometimes regard bearer securities negatively,
as they may be used to facilitate the evasion of regulatory
restrictions and tax. In the United Kingdom, for example, the
issue of bearer securities was heavily restricted firstly by
the Exchange Control Act 1947 until 1953. Bearer securities
are very rare in the United States because of the negative tax
implications they may have to the issuer and holder.
In the case
of registered securities, certificates bearing the name of the
holder are issued, but these merely represent the securities.
A person does not automatically acquire legal ownership by having
possession of the certificate. Instead, the issuer (or its appointed
agent) maintains a register in which details of the holder of
the securities are entered and updated as appropriate. A transfer
of registered securities is effected by amending the register.
Securities and Global Certificates
has developed to eliminate both the need for certificates and
maintenance of a complete security register by the issuer. There
are two general ways this has been accomplished.
jurisdictions, such as France, it is possible for issuers of
that jurisdiction to maintain a legal record of their securities
In the United
States, the current "official" version of Article 8 of the Uniform
Commercial Code permits uncertificated securities. However,
the "official" UCC is a mere draft that must be enacted individually
by each of the U.S. states. Though all 50 states (as well as
the District of Columbia and the U.S. Virgin Islands) have enacted
some form of Article 8, many of them still appear to use older
versions of Article 8, including some that did not permit uncertificated
Certificates and Book Entry Interests
to facilitate the electronic transfer of interests in securities
without dealing with inconsistent versions of Article 8, a system
has developed whereby issuers deposit a single global certificate
representing all the outstanding securities of a class or series
with a universal depository. This depository is called The Depository
Trust Company, or DTC. DTC's parent, Depository Trust &
Clearing Corporation (DTCC), is a non-profit cooperative owned
by approximately thirty of the largest Wall Street players that
typically act as brokers or dealers in securities. These thirty
banks are called the DTC participants. DTC, through a legal
nominee, owns each of the global securities on behalf of all
the DTC participants.
traded through DTC are in fact held, in electronic form, on
the books of various intermediaries between the ultimate owner,
e.g. a retail investor, and the DTC participants. For example,
Mr. Smith may hold 100 shares of Coca Cola, Inc. in his brokerage
account at local broker Jones & Co. brokers. In turn, Jones
& Co. may hold 1000 shares of Coca Cola on behalf of Mr.
Smith and nine other customers. These 1000 shares are held by
Jones & Co. in an account with Goldman Sachs, a DTC participant,
or in an account at another DTC participant. Goldman Sachs in
turn may hold millions of Coca Cola shares on its books on behalf
of hundreds of brokers similar to Jones & Co. Each day,
the DTC participants settle their accounts with the other DTC
participants and adjust the number of shares held on their books
for the benefit of customers like Jones & Co. Ownership
of securities in this fashion is called beneficial ownership.
Each intermediary holds on behalf of someone beneath him in
the chain. The ultimate owner is called the beneficial owner.
This is also referred to as owning in "Street name".
Depositories: Euroclear and Clearstream
DTC, two other large securities depositories exist, both in
Europe: Euroclear and Clearstream.
and Undivided Security
"divided" and "undivided" relate to the proprietary nature of
security constitutes a separate asset, which is legally distinct
from each other security in the same issue. Pre-electronic bearer
securities were divided. Each instrument constitutes the separate
covenant of the issuer and is a separate debt.
securities, the entire issue makes up one single asset, with
each of the securities being a fractional part of this undivided
whole. Shares in the secondary markets are always undivided.
The issuer owes only one set of obligations to shareholders
under its memorandum, articles of association and company law.
A share represents an undivided fractional
part of the issuing company. Registered debt securities also
have this undivided nature.
and Non-fungible Security
"fungible" and "non-fungible" relate to the way in which securities
If an asset
is fungible, this means that when such an asset is lent, or
placed with a custodian, it is customary for the borrower or
custodian to be obliged at the end of the loan or custody arrangement
to return assets equivalent to the original asset, rather than
the identical asset. In other words, the redelivery of fungibles
is equivalent and not in specie (identical).
securities are always fungible by logical necessity. Divided
securities may or may not be fungible, depending on market practice.
The clear trend is towards fungible arrangements.
In the United
States, the public offer and sale of securities must be either
registered pursuant to a registration statement that is filed
with the U.S. Securities and Exchange Commission (SEC) or are
offered and sold pursuant to an exemption therefrom. Dealing
in securities is heavily regulated by both federal authorities
(SEC) and state authorities. In addition the industry is heavily
self policed by Self Regulatory Organizations (SROs), such as
FINRA (the Financial Industry Regulatory Authority, formerly
the National Association of Security Dealers or NASD) or the
Due to the
difficulty of creating a general definition that covers all
securities, Congress attempts to define "securities" exhaustively
(and not very precisely) as: "any note, stock, treasury stock,
security future, bond, debenture, certificate of interest or
participation in any profit-sharing agreement or in any oil,
gas, or other mineral royalty or lease, any collateral-trust
certificate, preorganization certificate or subscription, transferable
share, investment contract, voting-trust certificate, certificate
of deposit for a security, any put, call, straddle, option,
or privilege on any security, certificate of deposit, or group
or index of securities (including any interest therein or based
on the value thereof), or any put, call, straddle, option, or
privilege entered into on a national securities exchange relating
to foreign currency, or in general, any instrument commonly
known as a 'security'; or any certificate of interest or participation
in, temporary or interim certificate for, receipt for, or warrant
or right to subscribe to or purchase, any of the foregoing;
but shall not include currency or any note, draft, bill of exchange,
or bankers' acceptance which has a maturity at the time of issuance
of not exceeding nine months, exclusive of days of grace,
or any renewal thereof the maturity of which is likewise limited."
- Section 3a item 10 of the 1934 Act.
to investment schemes that do not fall within the traditional
categories of securities listed in the definition of a security
(Sec. 2(a)(1) of the 33 act and Sec. 3(a)(10) of the 34 act) the
US Courts have developed a broad definition for securities that
must then be registered with the SEC. When determining if there
a is an "investment contract" that must be registered the courts
look for an investment of money, a common enterprise and expectation
of profits to come primarily from the efforts of others. See SEC
v. W.J. Howey Co. and SEC v. Glenn W. Turner Enterprises,
- Investment Banking - A concise, illustrated introduction to
investment banking and the issuance of new securities.