Securities Explained: Types, Categories & Trading in the US

A security is a financial instrument, typically any financial asset that can be traded. The nature of what can and can’t be called a security generally depends on the jurisdiction in which the assets are being traded.

In the United States, the term broadly covers all traded financial assets and breaks such assets down into three primary categories:

1. Equity securities – which includes stocks
2. Debt securities – which includes bonds and banknotes
3. Derivatives – which includes optionsOptions: Calls and PutsAn option is a derivative contract that gives the holder the right, but not the obligation, to buy or sell an asset by a certain date at a specified price. and futuresFutures ContractA futures contract is an agreement to buy or sell an underlying asset at a later date for a predetermined price. It’s also known as a derivative because future contracts derive their value from an underlying asset. Investors may purchase the right to buy or sell the underlying asset at a later date for a predetermined price.

Types of Securities

1. Equity securities

Equity almost always refers to stocks and a share of ownership in a company (which is possessed by the shareholder). Equity securities usually generate regular earnings for shareholders in the form of dividendsDividendA dividend is a share of profits and retained earnings that a company pays out to its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend.. An equity security does, however, rise and fall in value in accord with the financial markets and the company’s fortunes.

2. Debt securities

Debt securities differ from equity securities in an important way; they involve borrowed money and the selling of a security. They are issued by an individual, company, or government and sold to another party for a certain amount, with a promise of repayment plus interest. They include a fixed amount (that must be repaid), a specified rate of interest, and a maturity date (the date when the total amount of the security must be paid by).

Bonds, bank notes (or promissory notes), and Treasury notes10-Year US Treasury NoteThe 10-year US Treasury Note is a debt obligation that is issued by the US Treasury Department and comes with a maturity of 10 years. are all examples of debt securities. They all are agreements made between two parties for an amount to be borrowed and paid back – with interest – at a previously-established time.

3. Derivatives

DerivativesDerivativesDerivatives are financial contracts whose value is linked to the value of an underlying asset. They are complex financial instruments that are are a slightly different type of security because their value is based on an underlying asset that is then purchased and repaid, with the price, interest, and maturity date all specified at the time of the initial transaction.

The individual selling the derivative doesn’t need to own the underlying asset outright. The seller can simply pay the buyer back with enough cash to purchase the underlying asset or by offering another derivative that satisfies the debt owed on the first.

A derivative often derives its value from commodities such as gas or precious metals such as gold and silver. Currencies are another underlying asset a derivative can be structured on, as well as interest rates, Treasury notes, bonds, and stocks.

Derivatives are most often traded by hedge funds to offset risk from other investments. As mentioned above, they don’t require the seller to own the underlying asset and may only require a relatively small down payment, which makes them favorable because they are easier to trade.

Related Readings

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To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:

• Financial AssetsFinancial AssetsFinancial assets refer to assets that arise from contractual agreements on future cash flows or from owning equity instruments of another entity. A key
• Key Players in the Capital MarketsKey Players in the Capital MarketsIn this article, we provide a general overview of the key players and their respective roles in the capital markets. The capital markets consist of two types of markets: primary and secondary. This guide will provide an overview of all the major companies and careers across the capital markets.
• Investing: A Beginner’s GuideInvesting: A Beginner's GuideCFI's Investing for Beginners guide will teach you the basics of investing and how to get started. Learn about different strategies and techniques for trading
• Trading MechanismsTrading MechanismsTrading mechanisms refer to the different methods by which assets are traded. The two main types of trading mechanisms are quote driven and order driven trading mechanisms