Securities: Types of Investments & How They Work

by Unknown 9:19 AM 0 comments Investment Theory Securities

One of the most basic concepts in our Investment Theory is the understanding of the word Securities and its deviations. It is essential to know when you are investing WHAT you are investing in. Having said this, many people have no idea what they are investing in and even if they have a vague idea, they will definately not take into account its many pro's and con's. Here is where you can outwit them.
There are THREE different types of SECURITIES: debt securities, equity securities and derivative securities.


Debt securities are equivalent to lending money with an expected eventual return (plus interest of course), in other words bonds. Debt means owing something, this implies someone has lent you something and the inevitable destiny of the object being returned to the owner. This is basically how bonds work. You buy a piece of paper, this piece of paper is exactly like a cheque, the difference is you can only cash it out after a certain amount of time. This of course is a simplification of what a bond really is as you have many types of bonds (zero-coupon bonds, return notes,  ...) as well as many different organisations that issue them (treasuries, governments, regios, supranational entities, firms). These all work in different ways, with variations in issuer, priority, coupon rate (interest rate of a coupon) and redemption features the bond will be classified in a different category. Answering your question, YES, there is a bond quality ranking which works sort of like your A to F grading criteria. For more information on bonds click here.


Equity securities are more commonly known as equities. An equity is part of a company, being either capital stock, trust or partnership. The most commonly known are capital stock, or simply stock. Stock is, literally, a piece of paper that states you are a part-owner of a firm. By owning a certain amountof stock you are usually eligible to dividend, which is your share of the profit made by the firm. By owning a firm´s stock you become a stakeholder, meaning you have a certain interest in the firm doing well. Stock is usually traded in the stock markets (NASDAQ, NYSE, Dow Jones, CAC40, DAX30) also know as indicies. This stock is bought and sold (long/short) by shareholders everyday. The exchange of this causes the fluctuation in their price, at the same time increasing or decreasing the value of the firm itself. This is why percentages of companies go public (IPO's) since they wish not be 100% conditioned by the expectations of the shareholders. To learn more about equities click here. 


Derivative securities are options, futures, swaps, forwards, CFD's and so on. All of these mostly come originally from the trading of equities and bonds. They usually derive from the performance of an entity, asset, index or interest rate. Forwards, for instance, are the trading (more like the promise of a trade) at a given value of a stock. It divides in two parties, one the risk taker who will buy the stock at the end of the period, and two the owner, who will sell the stock to the risk taker. for both options and futures the risk taker is paid a certain amount of money for taking the risk. Farmers use this a lot in order to ensure a fixed amount of money as the value of their crop will fluctuate with the market. This is pretty easy to understand with a given example. 


(e.g.)
Take person A has a Coke stock currently selling at $100. Person A wants to sell the stock but is in no hurry because he thinks the stock will keep on rising. So he calls his dad and say, ''Hey Dad, I want to sell this stock in a year at a price of $106''. His dad accepts with the condition that he will be paid $5 right now. ---> 1 year afterwards ---> So now person A sells the bond to his Dad for the price they agreed on one year ago. There are two possibilities. Forward Z, where the stock's value increased to $110. Person A could have made more money but is still satisfied since he made $1 more what he would have made a year ago. And his Dad is even happier since he made $9. Forward Y, where the stock's value dropped to $98. On the one hand, person A could have lost $2 but instead he made 1$. His Dad, on the other hand, lost $3. 

This clearly explains how the risk taker, obviously takes the risk as he is the only one who is really making or losing money. If you want to learn more about derivative securities click here.
Well that is all for today. Remember always to compare amongst these and chose depending on how much money you are willing and able to lose, how much you know and understand the market, and the amount of time you have available. Money is time my friends. The more you know the better you are off competing against everyone else. Remember their loss is YOUR gain.