Financial Securities: Types, Trading, Risks & Portfolio Benefits

If you have spent any amount of time planning for your future, you probably know the importance of financial planning and investing. The importance of investing cannot be overstated in today’s world. There are a variety of financial securities on offer in the market. This makes it imperative for investors to understand what financial securities are, their features, associated risks and benefits, and how they are traded. Read on to understand the concept of financial securities in greater detail.

What are Financial Securities?

A financial security is a tradable asset that represents ownership, rights associated with ownership, and a relationship to the creditor. Financial securities can be of various types and play a major role in the global economy. A financial instrument qualifies as a security if it has a monetary value and if it can be traded in the public or private markets. Stocks, debentures, bonds, or futures contracts are examples of financial instruments. These instruments have a monetary value and represent ownership.

Types of Securities

Investors should be aware of the various types of financial securities. Selecting the right financial security can help you build a sound portfolio to help achieve your financial goals.

Equity

Equity is a common type of financial security and refers to a stake or ownership in a company offering the equity. Commonly known as stocks or shares, these financial securities represent ownership in the company and give the investors voting rights. Equity, in the form of shares, allows the investor to benefit from the appreciation in the stock price and the dividends distributed by the company. Equity shares are bought and sold on the stock exchanges or through private investments.

Debt Securities

Debt refers is an amount of money owed by one party to another. Companies raise funds by borrowing from banks or financial institutions. In some cases, a company might issue debt securities, such as bonds or debentures, to borrow money from the public. When investors purchase debt securities, they earn regular income in the form of interest; the principal amount is paid back to the investor upon maturity of the security. Government securities, such as treasury bills, are also considered debt securities.

Derivatives

A derivative contract is a financial instrument that derives its value from the underlying asset, such as a stock, commodity, or currency. A change in the price of the underlying asset leads to a change in the value of the derivative contract. Futures and options (F&O) are popular derivative instruments that are used by investors and traders to hedge their positions or speculate on the price of an asset.

Hybrid Securities

A hybrid security contains the features of both equity and debt securities. Such securities help investors earn a fixed income, along with benefiting from capital gains. Preference shares and convertible bonds are examples of hybrid securities.

Legal and Regulatory Aspects

While investing or trading in financial securities, one should know the legal and regulatory aspects associated with the instruments.

In India, the Securities and Exchange Board of India (SEBI) is the apex regulatory body that monitors the securities market. It puts in place regulations and issues guidelines to safeguard the interests of investors while promoting transparency in the market. SEBI plays a crucial role in keeping parties issuing securities accountable, along with preventing any fraudulent activity.

SEBI has put in place rules and regulations for various financial securities. Investors should make sure that their investment decisions comply with these regulations and fall within the legal framework.

How Are Securities Traded?

For a financial instrument to be considered a security, one should be able to buy and sell the instrument in a public or private market. Let’s look at the various ways in which financial securities are traded.

Stock Exchanges

A stock exchange, also known as a stock market, is a place where shares of public companies are listed. Investors can buy and sell shares of various companies on the stock market. Equity derivative contracts are also traded on stock exchanges.

Over-the-Counter (OTC) Markets

For a security to be traded, a buyer and a seller are needed. In an OTC market, buyers and sellers directly trade with each other. Securities such as unlisted shares and bonds are traded in an OTC market.

Private Placement

In some cases, financial securities may be traded privately. When a company wants to raise funds, it may issue equity shares or debt securities privately to investors such as banks or financial institutions.

Risks and Returns of Financial Securities

For any investor, understanding the risks and the returns of a financial security is vital. Investing according to your risk profile can help you make wiser investment decisions and stay invested for longer.

• Equity carries high risk and offers high returns.
• Debt securities carry low risk and offer lower but predictable returns.
• Derivatives carry very high risk and have the potential to generate very high returns, but can also result in substantial losses.

Importance of Financial Securities in Portfolio Building

Building a robust portfolio can help investors generate returns and grow their capital. With the help of financial securities, investors can build a portfolio that fits their risk profile. Investors with a higher risk appetite can build an equity-oriented portfolio, while investors with a lower risk appetite can opt for debt securities.

However, it is important to diversify your portfolio by investing in several asset classes. Diversification helps to spread risk across numerous asset classes and prevents excess concentration.

Role in Financial Planning and Trading

Financial securities make up a significant chunk of the investment plan of investors. Creating an investment portfolio can help one achieve financial freedom, create an emergency fund, or earn regular income. In the case of traders, they need to be careful while selecting the financial securities to trade in. 

Having a favourable risk-to-return ratio can be beneficial in your trading and investing journey.