Marketable Securities

Short-term financial instruments that can be liquidated at the current market prices.

Author: David Bickerton
David Bickerton
David Bickerton
Asset Management | Financial Analysis

Previously a Portfolio Manager for MDH Investment Management, David has been with the firm for nearly a decade, serving as President since 2015. He has extensive experience in wealth management, investments and portfolio management.

David holds a BS from Miami University in Finance.

Reviewed By: Patrick Curtis
Patrick Curtis
Patrick Curtis
Private Equity | Investment Banking

Prior to becoming our CEO & Founder at Wall Street Oasis, Patrick spent three years as a Private Equity Associate for Tailwind Capital in New York and two years as an Investment Banking Analyst at Rothschild.

Patrick has an MBA in Entrepreneurial Management from The Wharton School and a BA in Economics from Williams College.

Last Updated:December 12, 2023

What are Marketable Securities?

Marketable securities (MS) are short-term financial instruments that can be liquidated at the current market prices. These are liquid assets easily converted into cash listed under the current head assets in the company’s balance sheet.

The best examples are Treasury bills, commercial paper, and other money market instruments. 

There are four types of securities: debt, equity, derivative and hybrid securities. 

These financial assets tend to be highly liquid since they are expected to last less than a year with little to almost no virtual effect on the prices for which they can be bought or sold. 

These highly liquid investments have a low return since they are considered safe investments. In the corporate context, businesses mostly use securities to generate interest since this permits them to generate income instead of having idle cash.

MS also consists of an efficient and agile secondary market that permits investors to buy and sell. The secondary market consists mostly of retail and institutional investors engaging in day-to-day transactions.

Security holders are entitled to certificates that let the owner enjoy certain rights just by possessing this security, such as the same liability limits that private corporations for profit stockholders have.

    Key Takeaways

    • Investors will mostly prefer holding marketable securities since they offer a better return on investment than holding idle cash and can convert quickly into cash compared to other assets. The most important factors to consider about these securities are the following:
    • They can be divided into four categories: debt, equity, derivative and hybrid securities.
    • There is a low return for the investors since these investments are very liquid and low volatile.
    • These securities can also be purchased in primary and secondary markets by retail and institutional investors.
    • Financial analysts can use several financial ratios to know how capable a business is of meeting its short-term financial obligations, such as the cash, current and quick ratios.
    • Their expiration period is usually a year or less, and they are listed as current assets.
    • Since they are considered current assets, they participate in working capital calculations, which subtracting current assets can obtain with current liabilities.
    • Investors hold these securities for trading or maturity purposes to either make a short-term or long-term profit.
    • Investors prefer these securities since they are highly liquid, serve as alternative financing for short-term liabilities, keep the company solvent, and are very low risk.
    • Companies may think twice when trying to raise capital through these securities since they can face legal risks, shortcomings of interest payments to investors, risk of losing assets being put for collateral, the influence of stockholders over business decisions, and dividend payment without tax exemptions.

    Investor And Markets Types

    Investors & their investment practices will differ depending upon their use and investment philosophies. The markets present in the economy will aid in raising funds and will be utilized by the corporates per their needs.

    1. Investor Types

    There are two types of investors who can hold securities; retail and institutional. 

    The main difference between these two types of investors is usually the volume of securities purchased since institutional investors purchase great amounts of securities due to the funds they manage on behalf of their clients.

    Institutional investors can be investment banks, insurance companies, and pension funds, while retail investors are individual investors who buy and sell securities through brokerage firms.

    2. Market Types

    Securities can either be purchased in primary or secondary markets. The main difference is who the investor purchases the security from. 

    In the primary market, the purchaser obtains access to the security from the issuer, usually in an IPO. In contrast, securities are purchased from other investors instead of the issuer in the secondary market.

    An Initial Public Offering (IPO) permits the issuer to sell securities directly to investors, which happens when a company becomes public to raise capital from retail or institutional investors holding equity in the company.

    Investment banks usually handle the IPO of companies when trying to become public with the approval of certain regulatory bodies such as the Securities and Exchange Commission (SEC). 

    Investment banks purchase the entire issue of the company’s IPO at a discount to resell it at a markup; this is called firm commitment underwriting. 

    Purpose of Marketable Securities

    MS can be analyzed to know how capable a firm is of meeting its short-term financial obligations. Analysts, for this matter, commonly use liquidity ratios such as cash and current and quick ratios.

    1. Cash Ratio

    With the help of highly liquid financial assets, including cash, cash equivalents, and marketable securities, the cash ratio assesses a company’s capacity to meet its short-term financial obligations.

    This ratio is mostly used by creditors when figuring out how much capital they can lend a company.

    The formula used to calculate the cash ratio is the following:

    Cash Ratio = Cash + Cash Equivalents / Current Liabilities

    The cash ratio informs us of how much cash and cash equivalents the firm can use to meet its short-term debt obligations.

    Companies should aim to have a cash ratio of 1 or more since it would give creditors the impression that they can meet their short-term financial obligations. 

    • A ratio of 1: This would mean the company has enough highly liquid assets to pay its current liabilities.
    • A ratio of more than 1: The firm has more than enough cash and cash equivalents to pay its short-term debt. However, a ratio of more than one can signal poor cash utilization or that the company has too much idle cash.
    • A ratio of less than 1: The company cannot pay its short-term debt with its cash and cash equivalents; this would present an issue to the firm when looking for loans since it would give the impression that it is overleveraged and would be deemed a high-risk applicant.

    Certain exceptions may apply since most companies decide to invest their cash surplus into short-term investments bringing down the cash ratio. 

    The cash ratio is commonly used when analyzing a company’s industry averages. 

    2. Current Ratio

    The current or working capital ratio provides investors with information on how a company can utilize its current assets to satisfy its current liabilities.  

    An acceptable current ratio would depend on the industry standards of the company that is being evaluated. 

    Companies should aim for a ratio of 1 since the firm could cover its current debt obligations with its current assets. 

    A ratio of less than one would give the impression that the firm can’t cover its current liabilities. Conversely, a ratio of much more than one would suggest that the firm is not effectively investing its current assets.

    The formula for the current ratio would be the following:

    Current ratio = Current Assets / Current Liabilities

    Current assets include cash, inventory, accounts receivable, and other assets.

    Current liabilities would be wages, accounts payable, short-term debts, and the current portion of long-term debt.

    The principal limitation of the current ratio is that it cannot be used to compare companies across different industries since each industry has its convention for settling its short-term debt. 

    3. Quick Ratio

    The quick ratio, the acid test ratio, gauges a company’s capacity to settle its short-term debt commitments with its most liquid assets. 

    Looking for assets that may be converted to cash in 90 days or less without suffering a major loss in value is one metric for determining the firm’s most liquid assets.

    The formula for the quick ratio would be the following:

    (Current Assets – Inventory – Prepaid Expenses) / Current Liabilities

    This ratio would use the most liquid ratios to settle its short-term debt: cash, cash equivalents, marketable securities, and net accounts receivable.

    Cash is the most liquid asset. 

    A company with a quick ratio of 1 or more would be regarded as a firm with enough highly liquid current assets to cover its current liabilities. 

    Understanding this, if a firm has a very high quick ratio, it may indicate that it is sitting on surplus cash instead of using it for investing operations or expanding. 

    Types of Marketable Securities

    Marketable securities (MS) are often classified into four types: equity, debt, derivative, and hybrid.

    1. Equity Securities

    There are two types of equity securities; common and preferred. 

    Common shares are financial instruments that hold a percentage of ownership for a company that has issued shares; common stockholders can claim a company’s profits and vote decisions regarding the company’s board of directors.

    Preferred shares are stocks for which the owners pay dividends first than common stock owners in case the invested company goes bankrupt. They have no voting rights and have fixed dividends that remain unchanged.

    There are four types of preferred stocks: 

    1. Cumulative
    2. Non-cumulative
    3. Participating
    4. Convertible. 

    a) Cumulative preferred stock

    These types of preferred shares ensure the company pays the shareholders all dividends, including the ones that were due in the past.

    Unpaid dividends are considered in arrears and must go to the stock’s owner at the time of payment.

    Additional compensation is also awarded to the stock’s owner in the type of interest.

    Quarterly Dividend = [(Dividend Rate) x (Par Value)] / 4

    Cumulative Dividends per share = Quarterly Dividend x Number of Missed Payments

    b) Non-cumulative preferred stock

    Non-cumulative preferred stock doesn’t consider any past or omitted dividends for the stockholder. So, for example, suppose the company decides not to pay dividends. In that case, the stockholder can’t do anything.

    c) Participating in preferred stock 

    Shareholders are paid dividends at an amount equal to the specified rate of preferred dividends with an additional dividend. 

    The additional dividend would be paid out depending on the number of dividends given to common shareholders if it’s greater than an already set per-share amount.

    d) Convertible preferred stock

    Convertible preferred shares allow the shareholder to turn their stocks into a predetermined number of common shares after a pre-established time. 

    The correct method to account for equity security would depend on the time that it would be expected to be on the balance sheet. 

    Security held for less than a year would be accounted as a current asset, and equity security over a year would be a non-current asset.

    It’s important to note that when a company tries to buy or control a company with the acquisition of common stock, it would no longer be accounted as a current or non-current asset but as a long-term investment.

    2. Debt Securities

    These types of securities represent capital borrowed and must be repaid while considering its interest rate, borrowed amount, and maturity date. They are commonly short-term investments, so they are expected to be sold within a year. 

    Debt securities give the owner a stream of income in interest payments, and the principal initially paid for the bond’s purchase. Examples of debt securities would be government bonds, municipal bonds, collateralized bonds, and zero-coupon bonds.

    Two types of entities can issue bonds; governments or corporations. Governments sell bonds with a relatively low return since they usually represent very low risk; conversely, corporations issue bonds that give holders higher returns and risks.

    These entities issue bonds to raise capital to invest in a project or, in the case of a corporation, to engage in new business ventures. 

    The return that corporations could give depends on their credit rating, which would give the security holder a lower interest rate than a firm with a lower credit rating. 

    A corporation’s credit rating depends on how its balance sheet compares to the industry in which it’s competing; a stronger balance sheet in a mature industry would translate into a higher credit rating. 

    The investor’s risk aversion would be the main factor when deciding to invest in bonds or stocks since bonds represent a lower risk and return than stocks. 

    3. Derivative Securities

    Derivatives are financial instruments whose value relies on the value of another asset; the 4 main types are:

    1. Futures
    2. Swaps
    3. Forwards
    4. Options

    a) Future Contract

    Future contracts are standardized agreements between two interested parties that trade on a regulated exchange to trade a commodity at a specified time.

    Hedgers and speculators use these types of contracts.

    Hedgers purchase an underlying asset to ensure that they have a satisfactory price against any changes in the market.

    Speculators, on the other hand, instead of hedging on any changes in the market, use future contracts to profit on changes that may occur before the contract’s delivery date.

    There are different future contracts regarding the markets on which they are traded. However, the most common markets would be agriculture, energy, metal, currency, and finance. 

    b) Swap Contract

    A swap is a contract in which two participants trade cash flows or liabilities from different financial instruments.

    One of the most common swaps is the interest rate swap, this type of contract consists of exchanging the interest payments of a floating rate for a fixed rate of a principal amount.

    c) Forward Contract

    Since a forward contract involves the purchase of an underlying on a specific date, it is quite similar to a future contract. The only distinction is that this kind of contract can be tailored more and is less suitable for retail investors.

    These contracts do not trade on a public exchange since, unlike futures, these are not standardized contracts for the retail investor to trade.

    d) Options

    Options are financial instruments whose value relies on the underlying security price purchased by the investor. The investor can buy or sell the security within the timeframe set by the contract. 

    4. Hybrid Securities

    Hybrid securities or hybrids comprise equity and debt since they combine several financial instruments in a single security. Preferred shares and convertible bonds are the most common types of hybrid securities. 

    Preferred shares are issued by companies giving the stockholder an advantage over common stockholders since they are paid first and obtain more dividends but are limited to no voting rights in the company’s policies.

    These shares are paid based on LIBOR standards. They have a combination of equity and debt characteristics since they pay fixed dividends and equity with the opportunity of appreciating.

    If the company faces economic distress, the preferred shareholder would be prioritized when the assets are liquidated. 

    Corporate bonds are debt instruments that yield the holder fixed-income interest payments and have the advantage of being converted into a certain number of common stock in the future. 

    The factors that can affect the price of this type of security are the interest rates, the price of the underlying stock, and credit rating.

    There are two types of convertible bonds: 

    • Vanilla convertible bonds allow the holder to convert the security into stock or keep it as a bond
    • Mandatory convertible bonds are supposed to be converted at a certain conversation ratio and price level

    Marketable Securities Characteristics

    Marketable securities usually share the same characteristics regardless of the type since they commonly have the following:

    1. The expiration period of a year or less: Securities are often displayed under current assets in the balance sheet since they come under the holder’s ownership and are expected to be under him for a year or less.
    2. They can be traded in primary and secondary markets: The markets under which the security can be traded would depend on the issuer. Primary markets consist of the issuer being the company or the investment bank that manages the company’s IPO and sells the security directly to the investor. On the other hand, secondary markets consist of the retail or institutional investor selling to other investors without the issuer’s participation.
    3. Have high liquidity and, for that matter, low-risk: MS is very liquid since the rates upon which they are bought or sold have little effect on their prices. Another characteristic is that these securities are expected to be sold in a year or less, becoming almost as liquid as cash and its equivalents. 
    4. Not cash or its equivalents: They are not the same as cash equivalents but are similar in that they are highly liquid. These types of securities are current assets with very low risk and transparent pricing in the market, permitting the holder to use them if he is facing restrictions on cash. 

    Accounting for Marketable Securities

    MS is classified as current assets since their life span is usually less than a year and is owned by an individual or entity. Accordingly, these securities are usually reported under cash and cash equivalents in a company’s balance sheet.

    They are included in the working capital calculations since these securities are often considered current assets, and the calculation would be current assets minus current liabilities.

    Working Capital = Current Assets - Current Liabilities

    The investor may hold security for different reasons, the three most common of the following:

    1. Trading Purposes

    The main reason for trading MS is to make a short-term profit. 

    Often companies trade for short periods expecting capital gains, which industry trends or news announcements can influence.

    Traded securities appear in the balance sheet using the fair value method, where the value of the securities is equal to their current market value.

    2. Maturity Purposes

    The company or retail investor is not expecting to sell the security in the short run but instead expects to hold on to the security for the long run. 

    This is mainly for value investing since the investor expects the security to perform well in the long run.

    3. Available for Sale

    These types of securities are purchased to sell before the maturity date of said security or held before their maturity date. 

    Usually, unrealized gains or losses are not visible in the income statement since they appear in the other comprehensive income classification until these securities are sold.

    Having these securities may represent advantages to certain companies with limitations on cash management since they are highly liquid. 

    Short-term securities are almost as liquid as cash, an advantage to companies with conservative cash management policies. 

    Marketable Securities Advantages 

    Retail and institutional investors are well aware of the benefits of holding marketable securities, mostly due to their profitability compared to holding idle cash.

    The four most common advantages of marketable securities are the following:

    1. Highly Liquid: These securities are current assets, meaning they are the most liquid assets after cash and cash equivalents. Having idle cash sitting in a bank provides little to no return while having marketable securities provide a higher rate of return and easy transferability.
    2. Consolidation of Short-term liabilities: These types of securities are one of the best ways to finance short-term liabilities since they are very liquid and provide cash flow in terms of interest and dividends. Some short-term liabilities these securities can pay are income tax expenses, accounts payable, bonus expenses, and salaries. 
    3. Maintenance of Solvency Ratios: Companies must meet regulatory requirements to raise funds through the public, which are normally known as covenants. The demonstration of solvency within showcases a good current and liquid ratio, incentivizing creditors to lend to the company and investors to purchase their stock. 
    4. Low-Risk: MS are low-risk investments since they are very liquid, and because they represent such low volatility, they don’t give the holder a great return on investment. Having low volatility means there is less room for speculation for marketable securities since price quotes are usually available instantly. 

    Marketable Securities Disadvantages

    Companies face several detriments when issuing securities to investors since they become liable to make payments to the security holders. Moreover, in case of non-compliance, the company could face legal consequences. 

    The five main disadvantages of MS would be the following:

    1. Legal Risks: The bondholder has the right to take legal action if the loan is not paid, which would, in particular cases, force the company into bankruptcy.
    2. Interest Payments: Companies can face shortcomings when the interest expenses become unbearable. This can take a toll on their operations and profitability, so they are limited to the interest payments they can afford. 
    3. Collateral: Companies looking for financing would need to put certain assets for collateral to give the bondholder a sense of security in case he’s not repaid. 
    4. Stockholders Ownership: The stockholder can influence the business’s decisions, influencing the long-term strategy that management may have, with the possibility of losing control of the company later.
    5. Dividend Payments: The company must pay stockholders dividends periodically without enjoying tax-deduction benefits. 

    Researched and authored by Sadel Santos | LinkedIn

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