Securities 101: What can you "buy" on the Stock Market?
What are Securities?
Securities are financial instruments that have monetary value and can represent either an ownership relationship or a lender-borrower relationship. In many cases, securities are issued in what is known as a primary market and can be bought from and sold to other investors on the secondary market. The primary market is where securities are introduced to investors. The secondary market is where investors are allowed to buy and sell securities that were previously issued in the primary market. There are many different types of securities you can invest in, but for the purposes of this article, we will explain three types.
Types of Securities
Equity Securities: These are securities that represent ownership in a company. These securities are more commonly known as stocks and shares. Companies normally issue equity securities through an Initial Public Offering (IPO) when they need funds for business development or expansion.
An IPO is simply the process a company uses to issue shares to the public for the first time. By purchasing shares in a company, you become a partial owner of the company. As part owners of the company, some equity securities allow you the right to vote on company matters. Also, most companies overtime will begin to pay excess earnings to you in the form of dividends, providing a new income stream for you! It is important to understand that dividend payments are not guaranteed and are only distributed when deemed appropriate by the board of the company. Companies may choose to suspend or reduce dividends if the company is facing challenges or cash is needed to expand operations. An example of some popular equity securities in The Bahamas are Cable Bahamas, Commonwealth Bank and Arawak Port Development. If you do not mind a little risk when investing, equity securities can be a good fit for you.
Debt Securities: In simplest terms, debt securities represent a lender-borrower relationship between investors and companies, organizations, or governments. A common type of debt security is a bond.
Bonds are issued when entities need to borrow money, and investors are the lenders. Unlike equity securities, if you own bonds, you do not own a part of the business and you do not have the right to vote on company matters. However, if you purchase bonds the company essentially makes a promise to repay you with interest! The interest on bonds (called coupons) are normally paid in intervals stipulated by the company; normally quarterly, semi-annually or annually.
There is also a specified lifetime on bonds and at the end of the life of the bond, the investor is promised repayment of their principal (the amount initially invested). In The Bahamas, an example of bonds are government bonds, known as Bahamas Registered Stock. Debt holders also rank higher than both preference shares (explained next) and equity securities during bankruptcy settlements; therefore, if you are a conservative investor, these may be a good option for you!
Hybrid Securities: Hybrid securities are commonly those with characteristics of both equity and debt securities. An example of a hybrid security is a preference share. Like debt securities, if you purchase preference shares, you do not have the right to vote on company matters. Also, like debt securities, preference shares most commonly have a fixed dividend schedule. While some preference shares can be redeemed at certain points, some preference shares are like equity securities and have no maturity date. If you decide to buy preference shares, you can own them for life, if you choose not to sell them.
It is important to note that preference shares can be cumulative and non-cumulative, which can greatly affect how much income you receive from them. If a company faces challenges, they may choose to suspend the payment of dividends to preserve extra money for normal operations. With a cumulative preference share, your interest will build up and be paid in full once the company resumes dividend payments. With non-cumulative preference shares, if the company suspends payments, you will lose any interest that would have been expected until the company resumes dividend payments.
Given these reasons, the dividend rate on preference shares is usually higher than bonds due to higher risk that investors take on. In bankruptcy settlements, preference shares rank lower than debt securities but higher than equity securities. These can possibly be a good fit for you if you prefer some risk.
What Role do Securities play in our Economy?
The buying and selling of securities create what is known as the capital and money markets and are vital to economic growth in any society. In these markets, investors with excess capital are connected with those that need capital for business development and expansion. Many businesses that would not otherwise receive funding are able to access capital from investors looking to expand their portfolios and diversify their investments. With interest rates at very low levels today, securities allow you the opportunity to gain a higher return than that provided in low rate savings account. With this in mind, it is also important to understand that there are risks involved with investing in any security and so investors must balance risk with reward.
Investing can be challenging and exciting all at the same time! Learning about securities and how they work is a crucial step before diving into the world of investments. Luckily, we are here to help you GET MONEY SMART by helping you get familiar with some securities basics that everyone should know. For information of the types of investments, check out our flyer on the different types here.