Various Types of Investment Securities

A basic understanding of all possible types of investment securities is imperative for one to meet their financial objectives. In this post, we will give the basic definitions and descriptions of the various types of investment securities.

Shares are units of ownership held by an investor in a company. Investors are entitled to a distribution of profits of the company proportionate to the number of shares they hold in the company. So, the more shares they hold, the more dividends they are entitled to.

There are two types of shares: common (ordinary) shares and preference shares. Common stockholders (investors who own common shares) have voting rights in the company and as such can influence company decisions. However, if the company is liquidated, ordinary shareholders are given the least priority. Further, they may or may not receive dividends depending on the decisions of the directors. Preference shareholders do not have voting rights but are entitled to dividends. Furthermore, in the event of liquidation, they have a higher priority than ordinary shareholders.

Warrant

A warrant is a security that gives an investor the right, but not the obligation, to buy an underlying security at a specified price at a certain date. In this respect, warrants are like options. However, securities represented in the warrant are delivered directly by the company, unlike options where the securities are delivered by an investor holding the security. Typically, warrants are issued by companies. There are two types of warrants: call warrants and put warrants. Call warrants give the investor the right to purchase security whereas put warrants give the investor the option of selling the security.

Futures

A futures contract is a derivative instrument whereby an investor buys or sells a financial instrument or some commodity at a pre-determined price on or before a pre-determined date. Futures are standardised and traded on a futures exchange such as the Chicago Mercantile Exchange.

ETO’s

An ETO (Exchange Traded Option) is a type of derivative instrument whereby an investor either buys or sells a specific quantity of a given financial asset at a pre-determined price on or before a pre-determined date. A derivative instrument is a financial asset whose value is dependent on an underlying variable i.e. it derives its value from an underlying variable. The underlying variable may be stocks or a commodity such as maize. The difference between ETO’s and futures is that ETO’s involve call options or put options.

Listed managed investment

Managed investments are securities whereby investors funds are pooled together and invested by a professional fund manager in a variety of asset classes such as fixed interest instruments, equities, derivatives and other instruments. These funds are run by listed investment companies that are listed on the market.

Interest Rate

The interest rate is the percentage of principal charged by a lender for the use of his money. Typically, the interest rate is determined by three proponents: liquidity risk, inflation risk and credit risk. Liquidity risk is attributed to how liquid (ease of exchanging an asset to cash) the assets under the debt are. Inflation risk is attributed to how the purchasing power of a given amount reduces with time. Credit risk is attributed to default on the part of the debtor. The amount of interest charged is proportional to the amount of risk in the debt. The most basic example is the interest rate charged by your local bank. Since the inflation rate of goods within the country is standard, inflation risk has little bearing on the interest rate charged. Liquidity risk affects interest rates significantly. Taking a mortgage may have a higher liquidity risk than a loan for a car since selling off real estate may be more difficult than selling off the car in case of default. However, credit risk has the largest bearing on interest rates. There are multiple factors that come into play when it comes to credit risk such as an individual’s income, their age, their education and such. A wealthy individual has a higher chance of paying a debt than a less wealthy individual.

Hybrid Securities

Hybrid securities are financial instruments that combine two or more different financial instruments. They typically exhibit both equity and debt characteristics. One such instrument is a convertible bond. It has debt characters in that it’s a bond. It also has equity characteristics in that the security can be converted into shares.