Financial instruments that generally represent ownership or debt.

Author: Adin Lykken
Adin Lykken
Adin Lykken
Consulting | Private Equity

Currently, Adin is an associate at Berkshire Partners, an $16B middle-market private equity fund. Prior to joining Berkshire Partners, Adin worked for just over three years at The Boston Consulting Group as an associate and consultant and previously interned for the Federal Reserve Board and the U.S. Senate.

Adin graduated from Yale University, Magna Cum Claude, with a Bachelor of Arts Degree in Economics.

Reviewed By: Christy Grimste
Christy Grimste
Christy Grimste
Real Estate | Investment Property Sales

Christy currently works as a senior associate for EdR Trust, a publicly traded multi-family REIT. Prior to joining EdR Trust, Christy works for CBRE in investment property sales. Before completing her MBA and breaking into finance, Christy founded and education startup in which she actively pursued for seven years and works as an internal auditor for the U.S. Department of State and CIA.

Christy has a Bachelor of Arts from the University of Maryland and a Master of Business Administrations from the University of London.

Last Updated:September 30, 2023

What is a Security?

Securities are financial instruments that generally represent ownership or debt. Commonly any marketable financial asset can be considered a security, but the definition can vary based on the laws. For example, in some places, the term excludes financial assets other than ownership and fixed income sources.

When it comes to accounting, financial statements always come to mind. This is because financial instruments are, in essence, contracts and therefore are at their core financial assets.

An example would be when an invoice is issued on sales done by credit, the party that has made the deal has a financial asset – the accounts receivable – while the party that purchases the goods has to account for a financial liability – the accounts payable

At fundamental strata, securities are monetary contracts between people or organizations that can be traded with the public. Assets come in many forms and are classified into current and noncurrent assets.

There are various financial instruments, such as bonds, stocks, and even invoices.

Three types of securities exist, equity securities which grant ownership rights to the certificate holder; debt securities—loans that promise periodic repayments; and hybrid securities—which have traits of both equity and debt securities.

The main reason for purchasing securities is an investment; it is done to make income or gain capital. Therefore, debt securities will typically provide a higher interest rate than bank deposits, and equities could offer the possibility of capital appreciation. 

Security Finance

One of the essential traits of financial securities is that they are tradeable, i.e., one can easily exchange them for cash. 

These contacts are considered liquid assets and are often accounted for when calculating liquidity ratios. Holding such contracts gives the holder a privilege to gain future financial benefits, detailed beforehand. 

Securities let you own the investment it represents without physically having it. The price of the contract indicates the value of the asset it means. The Higher the price, the higher the value of the investment.

However, derivatives are an exception as they represent the instruments being traded rather than the underlying asset.

Securities financing is when an individual or organization lends asset-backed securities to another individual or corporation in exchange for cash. In simplest terms, it is an investment that lets you own things without holding onto them. Stocks and bonds are examples of securities.

These financial instruments are labeled as securities because there is a secure financial contract that can be easily bought or sold on open markets. A famous example of a market where such assets can be exchanged is the New York Stock Exchange (NYSE).

An essential characteristic is for it to be fungible. In simple terms, the holder of the security has to be able to swiftly and efficiently exchange the asset for others of the same type.  Just like a pound sterling note can be replaced by another, a company bond can be swapped for a company bond from the same firm. 

Just like all one-pound notes can increase and decrease in value but still have the same value as each other, all company bonds can have fluctuations in their value but will still be equal in value to other company bonds in the same company.

Marketable Securities

In business terms, something is marketable if it can quickly be sold and is non-marketable if it is difficult to sell.

Marketable securities are securities easily bought and sold in a public market, such as a stock exchange. For example

Marketable securities are diagnosed by analysts when doing a liquidity ratio analysis on a business. Liquidity ratios measure a firm's ability to cover due liabilities within a year.

Investments or debts can be classified as either marketable or non-marketable securities. For example, government bonds and private company shares can be classified as non-marketable securities as they are difficult to buy and sell.

Firms generally allot cash as reserve funds in preparation for circumstances that would need them to cough up a lot of cash quickly. For example, the company might want to take advantage of an opportunity to acquire one of its rivals.

Rather than keeping all of its cash idle and gaining no return, businesses will sometimes purchase securities to generate extra wealth for the company. This can come from payments from the asset or the asset's appreciation.

This allows the business to earn returns on a portion of its cash which might devalue because of inflation. In addition, the company can easily liquidate its financial securities if a sudden need for liquidity arises. 

Marketable securities are very safe investments. However, this low risk means that they are generally low returns compared to riskier investments such as startup private limited company shares.

Stock VS Security

Security is ownership of an asset or debt that can easily be sold on an open market. Financial securities can mainly be classified into derivatives, debt, and equity. A stock is a specific security that gives the holder ownership in a public company

The Venn diagram below explains the relationship, where a stock is a subset within the definition of a security.

Venn Diagram

In the past, these financial instruments were represented by pieces of paper. However, now that the stock market has become digitized, they are represented on electronic files.

Stocks are financial instruments that give the holder equity in a publicly-traded corporation. In other words, owning a stock allows you to profit from a company's success while the company enjoys access to more significant capital.

Another word commonly associated with stocks is shares. It is a common mistake to think both are the same thing, but shares are the smallest denomination of a stock. 

There are two ways to generate wealth by owning shares in a company.

  • Through dividends, which are cash paid from the company's profits. So, for example, if a company has 2,000 outstanding shares and offers a $10,000 dividend, shareholders will receive $5 for each share in their ownership.
  • Through Capital appreciation. This is the rise in the value of shares in the company. For example, if you buy a share for $100, and the stock is worth $170, you have made $70.

Owning the majority of shares in a company allows you to indirectly control the company by appointing the board of directors of the company.

The board of directors is responsible for raising the company's value and often hires competent managers and professionals such as the CEO and CFO. However, ordinary shareholders do not manage the company unless they are employees.

There are mainly two types of shares, and these are common and preferred shares. One key difference between the two types of shares is that common shares give you voting rights, whereas preferred shares give preferred liquidation rights.

Sometimes called basic shares, common shares are the most common type of stock issued by companies. But despite sharing some similarities, common and preferred shares have differences in risk-return profiles and rights assigned to them. 

Types of Securities

The high liquidity of marketable securities, their monetary benefits, and the prospect of price appreciation make them very popular among individual and corporate investors. 

These investments can be debt or equity securities but can sometimes be classified as hybrid securities or derivatives. The latter of which represents the contract with an underlying security,

The entity that creates these financial instruments and offers them for sale is known as the issuer. On the other hand, those who purchase them are called investors. 

Traditionally, securities represent an investment and a means by which governments, businesses, and financial institutions can raise capital. Firms can make a lot of money during an initial public offering.

The original meaning of it regarding financial matters can be traced back to the mid-1400s. Back then, the property was pledged to guarantee some debt or promise of the owner. 

In the early 1600s, the word was used for a certificate proving a debt agreement between two parties and eventually for any document used for financial investment. By the latter half of the 1800s, the word could refer to any tradeable investment.

Nowadays, legally the definition of financial security varies between nations and jurisdictions. In general, though, these types of marketable assets can be classified into four types: debt securities, equity securities, hybrid securities, and derivative securities.

Debt securities

Debt securities such as company bonds, government bonds, or even certificates of deposits are a type of easily exchangeable loan. They act like IOUs from the issuer to the investor. An IOU (a shortened form of the phrase "I owe you") is typically a document that acknowledges debt. 

Holders of these instruments lend a certain amount of cash to another party in exchange for the principal amount to be paid back along with interest. That latter is obliged to pay interest payments to the holder until it matures periodically; once this happens, the debtor must absolve the debt to the owner.

Debt securities allow the temporary use of the owner's capital. In addition, it allows the owner to gain periodic interest payments against the debtor's temporary use of their cash. The most common type of this kind of asset is bonds. Bonds are units of corporate or government debt issued by an organization and traded as marketable assets.

Bonds are a type of debt instrument representing loans made to the issuer. Governments and businesses commonly issue bonds to borrow money in times of low liquidity or when much money is required for expansion. 

Governments need to finance roads, schools, hospitals, and other infrastructure. The sudden expense of war may also demand the need to raise funds. For example, during world war 2, the US government mainly raised war funds through bonds.

Similarly, the company will often borrow money to acquire other businesses, expand its operation, buy plants and machinery, invest in new and lucrative research and development projects, or hire more workers. 

The problem that large organizations face is that sometimes they need much more money than banks can provide, so they often issue debentures to the public.

Equity securities

Equity investors buy stocks in a company with the hopes of a rise in the price of the stock in the form of capital appreciation and/or through dividends paid from the firm's profits.

If an equity investment increases in value, the investor will grow their wealth by the difference in the new and old price of the instrument. Equity securities are financial instruments that represent ownership in a business.

Equity securities give the holder some degree of control over a company through privileges such as voting rights. Shareholders in a company are paid their dividends only after debts have been paid.

This security usually represents ownership in an organization. The financial instrument also grants the owner the right to some of the earnings of the issuer organization.

The most popular type of equity instrument is common stock, which gives its owner the right to a share of the residual earnings of the issuing company and allows them voting rights so they can be involved in the organization.

Another type of equity instrument includes preferred stock. These stocks do not carry voting rights but promise preferential dividend payments.

Depending on the restrictions of the stock, it might be possible to sell it to an external party. These are generally laid out in the shareholder agreement and may be terminated after an initial public offering.

Hybrid securities

This category of financial instruments has a combination of debt and equity characteristics. The original version of this was preferred stock, representing ownership in a company but having fixed payouts such as bonds.

Since then, businesses have structured financial instruments in various ways. Many of these types of securities require payments with a periodic rate of return and options for conversion to ownership. 

A debt security is less volatile as the possibility of changing it for shares at a particular time in the future allows for a reduction in investment risk.

The holder of a convertible debt security (convertible bond) can convert the document to a different type of asset. For example, the ability to transform a convertible into shares exemplifies how hybrid securities can reduce risk.

Another example of a hybrid would be capital notes. Capital notes have both share and bond characteristics but are unsecured and risky.

Portfolio diversification can lower many of the risks these kinds of instruments carry. For example, investors could help find hybrids that might be mispriced while building a portfolio to reduce the company's risk.


Derivatives represent underlying assets and carry their risks. Accordingly, derivatives prices are influenced by underlying asset price fluctuations. 

Derivatives started a few centuries ago. Merchants trading across kingdoms, empires, and republics used them to balance the exchange rate in different areas.

Derivatives were introduced to solve this problem. A few common types of derivatives include swaps, options, forwards, and futures, but there are others, such as:

  • Collateralized debt obligations (CDOs)
  • Credit default swaps
  • Mortgage-backed securities (MBS)

The main goal of such financial instruments is the reduction of risk. For example, put options allow the owner of the contract the right, but not the compulsion, to sell a specific quantity of an underlying asset at a price mentioned above within a particular date.

Derivatives can be risky, especially for those who are only starting out investing, since they are more complex and challenging to understand.

There are various purposes for derivatives depending on the derivative type. For example, derivatives project any asset's future price, avoid exchange rate issues, and hedge against asset value changes.

Key Takeaways

  • Stocks, bonds, and ETFs are the most common examples of financial instruments.
  • Investments in derivatives and hedge funds may also be marketable securities.
  • Financial securities have to be readily tradable and represent an underlying asset generally.
  • There exist current assets that are not financial securities, and there are financial securities that are not liquid assets.
  • The three types of such instruments are debt, equity, hybrid, and derivatives.
  • Equity investors buy stocks in a company with the hopes of a rise in the price of the stock in the form of capital appreciation and through dividends paid from the firm's profits.
  • Fluctuations influence the prices of derivatives in the underlying asset price. 
  • The high liquidity of marketable securities, their monetary benefits, and the prospect of price appreciation make them very popular among individual and corporate investors. 
  • Marketable securities are diagnosed by analysts when doing a liquidity ratio analysis on a business. Liquidity ratios measure a firm's ability to cover due liabilities within a year.
  • Investments or debts can be classified as either marketable or non-marketable.
  • Debt securities such as company bonds, government bonds, or even certificates of deposits are a type of easily exchangeable loan. 
  • An essential characteristic of financial securities is that they are fungible. In simple terms, the holder of the securities has to be able to swiftly and efficiently exchange the asset for others of the same type. 

Researched and written by Omair Reza Laskar | LinkedIn

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