Securities and type of securities

This article is written by Shubham Kaurav of Lloyd Law College, an intern under Legal Vidhiya,

INTRODUCTION:

Securities are financial instruments that represent ownership in a publicly traded company or represent a debt that is owed to an investor. The history of securities dates back to ancient times, when merchants would pool their resources to fund trade expeditions. These early securities were essentially equity investments in a venture, with profits and losses shared among investors.

In the modern era, the history of securities can be traced back to the early days of the stock market in the 17th century. The Amsterdam Stock Exchange, founded in 1602, is considered the first organized stock market. In the early days, stocks were issued by individual companies to raise capital for expansion, and investors bought and sold these stocks on the open market.

As the stock market grew and evolved, so too did the types of securities available to investors. In the 19th century, the development of railroads and other large-scale infrastructure projects led to the creation of bonds, which represented a debt owed to investors by a company or government entity.

In the early 20th century, the US Securities and Exchange Commission (SEC) was created to regulate the securities industry and protect investors from fraud and other abuses. Since then, the securities market has continued to evolve, with new financial instruments such as derivatives, exchange-traded funds (ETFs), and other complex securities becoming increasingly popular.

Today, securities represent a major component of the global economy, with trillions of dollars’ worth of stocks, bonds, and other securities traded on exchanges around the world. Despite occasional market crashes and financial scandals, securities remain a popular investment vehicle for individual and institutional investors alike.

There are two main types of securities: equity and debt. Equity securities, also known as stocks or shares, represent ownership in a company. When an investor purchases a stock, they become a shareholder in the company and are entitled to a share of the company’s profits and assets. Debt securities, also known as bonds or notes, represent a loan made by an investor to a company or government. When an investor purchases a bond, they are lending money to the issuer and are entitled to receive interest payments on a regular basis until the bond reaches maturity, at which point the principal is repaid.

In addition to stocks and bonds, there are other types of securities such as options, futures, and mutual funds. Options and futures are derivatives, which means that their value is derived from an underlying asset such as a stock or commodity. Options give the holder the right, but not the obligation, to buy or sell an underlying asset at a specific price within a specific time period. Futures are contracts that require the buyer to purchase or sell an underlying asset at a specific price and time in the future.

Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of securities. Mutual funds are managed by professional fund managers who invest the fund’s assets according to a specific investment objective.

Overall, securities play an important role in the global economy by providing a means of financing for corporations and governments and an opportunity for investors to invest their capital and earn a return. However, investing in securities involves risks, and investors should carefully consider their investment objectives, risk tolerance, and the specific features of the securities they are considering before making any investment decisions.

TYPES OF SECURITIES:

 Here is an overview of the main types of securities:

Stocks:

Stocks, also known as equities, represent ownership in a company. When you buy a stock, you become a shareholder and have a claim on the assets and earnings of the company. Stocks can be classified into different categories such as common stocks and preferred stocks.

Common stocks represent the majority of shares outstanding in a company and entitle the shareholder to vote on important company matters such as the election of directors and major corporate actions. Common stockholders are also entitled to receive dividends when the company declares them. Dividends are a portion of the company’s profits that are distributed to shareholders.

Preferred stocks, on the other hand, typically do not offer voting rights but provide a higher priority in receiving dividends and in the event of liquidation of the company’s assets. Preferred stocks are generally less risky than common stocks, but they also offer lower potential returns.

Stocks can be bought and sold on stock exchanges, such as the New York Stock Exchange and the NASDAQ, or over-the-counter markets. The price of a stock is determined by supply and demand and can fluctuate based on various factors such as the company’s financial performance, industry trends, and geopolitical events.

Investing in stocks can offer investors the potential for high returns, but it also involves significant risks. The value of stocks can be affected by market volatility, economic conditions, and company-specific factors such as management changes, product recalls, and legal issues.

It is important for investors to carefully evaluate their investment objectives, risk tolerance, and investment horizon before investing in stocks. It is also recommended to diversify investments across different companies, sectors, and geographic regions to manage risk. Professional financial advice can also be helpful in making informed investment decisions.

 Bonds:

Bonds are a type of debt security issued by companies, governments, and other entities to raise capital. When you buy a bond, you are essentially lending money to the issuer, who promises to pay you interest on the bond until it matures, at which point the principal is repaid.

Bonds are generally considered less risky than stocks because they offer a fixed rate of return, and the principal is repaid at maturity, assuming the issuer doesn’t default. The level of risk associated with a bond depends on the creditworthiness of the issuer. For example, bonds issued by governments and highly rated corporations are generally considered less risky than those issued by small companies or those with lower credit ratings.

Bonds can be classified into different categories based on the issuer and the characteristics of the bond, such as maturity date, interest rate, and whether the bond is callable or convertible. Some common types of bonds include:

1. Government Bonds: These are bonds issued by governments to fund their operations or pay off debt. Examples include U.S. Treasury bonds, German Bunds, and Japanese Government Bonds (JGBs).
2. Corporate Bonds: These are bonds issued by corporations to raise capital. Corporate bonds can be either investment-grade or high-yield (also known as “junk bonds”).
3. Municipal Bonds: These are bonds issued by state and local governments to finance public works projects such as schools, highways, and water systems. Municipal bonds are generally exempt from federal income taxes.
4. Treasury Inflation-Protected Securities (TIPS): These are bonds issued by the U.S. Treasury that are indexed to inflation. The principal value of TIPS adjusts to reflect changes in the Consumer Price Index (CPI), and interest is paid on the adjusted principal.
5. Zero-Coupon Bonds: These are bonds that do not pay interest but are issued at a discount to their face value. The bondholder receives the face value of the bond at maturity, which represents the interest earned on the bond.

Bonds can be bought and sold on bond markets, which are generally less liquid than stock markets. The price of a bond is affected by various factors such as changes in interest rates, inflation, and the creditworthiness of the issuer.

Investing in bonds can offer investors a relatively stable source of income and can be used to diversify a portfolio. However, like any investment, bonds also carry risks, such as credit risk, interest rate risk, and inflation risk. It is important for investors to carefully evaluate their investment objectives, risk tolerance, and investment horizon before investing in bonds. Professional financial advice can also be helpful in making informed investment decisions.

 Derivatives:

Derivatives are financial instruments that derive their value from an underlying asset or security. The underlying asset can be a stock, bond, commodity, currency, or any other asset. The value of a derivative is based on the price movements of the underlying asset.

Derivatives can be used for a variety of purposes, including hedging, speculation, and arbitrage. Hedging involves using derivatives to offset potential losses in other investments. Speculation involves taking a position in a derivative to profit from the expected price movements of the underlying asset. Arbitrage involves taking advantage of price differences between two or more markets.

Some common types of derivatives include:

1. Futures Contracts: These are contracts that require the buyer to purchase an underlying asset at a future date and at a predetermined price. Futures contracts are often used by producers and consumers of commodities to hedge against price fluctuations.
2. Options: These are contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price and within a specific time period. Options can be used for hedging or speculation purposes.
3. Swaps: These are agreements between two parties to exchange cash flows based on different underlying assets. The most common type of swap is an interest rate swap, where two parties exchange fixed and variable interest rate payments.
4. Forwards: These are contracts between two parties to purchase or sell an underlying asset at a future date and at a predetermined price. Forwards are similar to futures contracts, but they are not standardized and are traded over-the-counter.

Derivatives can be traded on organized exchanges, such as the Chicago Board of Trade and the New York Mercantile Exchange, or over-the-counter (OTC) markets. OTC derivatives are customized contracts negotiated between two parties and are not traded on an exchange.

Derivatives can offer investors the potential for high returns, but they also carry significant risks. Derivatives are highly leveraged and can result in large losses if the market moves against the investor’s position. It is important for investors to fully understand the risks associated with derivatives and to have a thorough understanding of the underlying asset before investing in derivatives. Professional financial advice can also be helpful in making informed investment decisions.

 Mutual funds:

Mutual funds are a type of investment vehicle that pools money from multiple investors to buy a portfolio of stocks, bonds, or other securities. The portfolio is managed by a professional investment manager, who selects the securities and makes investment decisions on behalf of the investors.

Mutual funds offer a number of benefits to individual investors, including diversification, professional management, and liquidity. Diversification allows investors to spread their investments across a broad range of securities, reducing the risk of losses due to any one security or market sector. Professional management means that investors do not have to spend time researching and selecting individual securities themselves. Finally, mutual funds are generally liquid, meaning that investors can buy and sell shares on any business day at the fund’s net asset value (NAV).

Mutual funds can be classified into different categories based on the types of securities they invest in, their investment objectives, and their risk levels. Some common types of mutual funds include:

1. Equity Funds: These are mutual funds that invest primarily in stocks. Equity funds can be further classified by investment style (such as growth or value) and market capitalization (such as large-cap or small-cap).
2. Bond Funds: These are mutual funds that invest primarily in bonds. Bond funds can be further classified by the type of bonds they invest in (such as government or corporate bonds) and by maturity (such as short-term or long-term).
3. Balanced Funds: These are mutual funds that invest in a mix of stocks and bonds, with the goal of providing a balance between income and growth.
4. Index Funds: These are mutual funds that seek to replicate the performance of a particular stock or bond index, such as the S&P 500 or the Barclays Aggregate Bond Index.
5. Sector Funds: These are mutual funds that invest in a particular sector of the economy, such as healthcare, technology, or energy.
6. International Funds: These are mutual funds that invest in securities from countries outside of the investor’s home country.

Mutual funds charge investors fees, such as management fees and operating expenses. These fees can vary widely depending on the fund, so it is important for investors to carefully evaluate the costs and benefits of each fund before investing. It is also important to consider the fund’s performance history, investment philosophy, and risk level before investing.

Overall, mutual funds can be a convenient and effective way for individual investors to gain exposure to a diversified portfolio of securities, but investors should do their due diligence and carefully evaluate their investment objectives and risk tolerance before investing. Professional financial advice can also be helpful in making informed investment decisions.

 Exchange traded funds :

Exchange-Traded Funds (ETFs) are a type of investment fund that tracks a specific index or a basket of securities, such as stocks, bonds, or commodities. ETFs are traded on stock exchanges like individual stocks, and their price fluctuates throughout the trading day as investors buy and sell shares.

ETFs offer several advantages to investors, such as low costs, flexibility, diversification, and transparency. ETFs are generally less expensive than traditional mutual funds because they typically have lower management fees and operating costs. ETFs also offer more flexibility than mutual funds, as they can be bought and sold like individual stocks throughout the trading day, providing investors with more control over their investments. ETFs also offer diversification benefits by providing exposure to a broad range of securities, reducing the risk of losses due to any one security or market sector. Finally, ETFs are transparent, as they publish their holdings daily, allowing investors to see exactly what securities the fund holds.

ETFs can be classified into different categories based on the types of securities they track and their investment objectives. Some common types of ETFs include:

1. Equity ETFs: These ETFs track the performance of a specific equity index, such as the S&P 500 or the Nasdaq 100.
2. Bond ETFs: These ETFs track the performance of a specific bond index, such as the Barclays Aggregate Bond Index.
3. Commodity ETFs: These ETFs track the performance of a specific commodity, such as gold or oil.
4. Currency ETFs: These ETFs track the performance of a specific currency or a basket of currencies.
5. Sector ETFs: These ETFs track the performance of a specific sector of the economy, such as healthcare, technology, or energy.
6. International ETFs: These ETFs track the performance of securities from countries outside of the investor’s home country.

ETFs are generally considered to be a low-cost, tax-efficient way to invest in the stock market or other securities markets. However, it is important to carefully evaluate the costs and benefits of each ETF before investing, including management fees, operating expenses, and any potential tax implications. Professional financial advice can also be helpful in making informed investment decisions.

 Real Estate Investment Trust:

A Real Estate Investment Trust (REIT) is a type of investment fund that owns and operates income-producing real estate properties. REITs are traded on stock exchanges like individual stocks, and they are required by law to pay out at least 90% of their taxable income to shareholders in the form of dividends.

REITs offer several advantages to investors, such as high dividends, diversification, and liquidity. Because REITs are required to pay out at least 90% of their taxable income to shareholders, they typically offer higher dividend yields than other types of stocks or mutual funds. Additionally, REITs provide diversification benefits by providing exposure to a broad range of real estate properties, such as office buildings, shopping malls, apartment complexes, and hotels. Finally, REITs are generally liquid, meaning that investors can buy and sell shares on stock exchanges like other types of stocks.

REITs can be classified into different categories based on the types of properties they own and their investment objectives. Some common types of REITs include:

1. Equity REITs: These REITs own and operate income-producing properties, such as office buildings, shopping malls, and apartment complexes.
2. Mortgage REITs: These REITs invest in mortgages and other real estate loans, rather than physical properties.
3. Hybrid REITs: These REITs combine the characteristics of equity and mortgage REITs, owning both physical properties and real estate loans.

REITs offer several potential benefits to investors, but it is important to carefully evaluate the costs and risks of each REIT before investing. REITs may charge fees and expenses, such as management fees and operating expenses, which can reduce returns. Additionally, REITs are subject to risks associated with real estate investing, such as changes in interest rates, economic conditions, and property values. Professional financial advice can be helpful in making informed investment decisions.

Case laws:

Balram Garg v. SEBI is a significant case related to insider trading and the Securities and Exchange Board of India (SEBI), which is the regulatory body for the securities market in India. Here is a brief overview of the case:

In 2013, SEBI initiated an investigation into alleged insider trading by Balram Garg, who was the chairman and managing director of a company called PC Jeweller. The investigation was based on information that Garg had sold a significant number of shares in the company shortly before a negative earnings announcement was made to the public.SEBI found that Garg had indeed engaged in insider trading and had made a profit of over Rs. 7.5 crores ($1 million) from the sale of the shares. SEBI issued an order against Garg, prohibiting him from accessing the securities market and directing him to disgorge the illegal gains that he had made.Garg appealed SEBI’s order to the Securities Appellate Tribunal (SAT), which is a quasi-judicial body that hears appeals against SEBI’s orders. SAT upheld SEBI’s order and directed Garg to pay the disgorged amount with interest.Garg then appealed to the Supreme Court of India, which dismissed his appeal and upheld SEBI’s order. The Supreme Court held that Garg had violated the insider trading regulations and that SEBI was justified in imposing the penalties.

This case is significant because it highlights the importance of enforcing regulations related to insider trading and the role of SEBI in regulating the securities market. It also demonstrates the consequences that individuals can face for engaging in insider trading, including the disgorgement of illegal gains and prohibition from accessing the securities market.

Conclusion:

Securities investments can offer prospects for portfolio diversification and growth. Before making any investing decisions, it’s crucial to comprehend the dangers connected to each type of asset and to carefully assess your investment objectives and risk tolerance. If you’re unclear of how to invest your money, it’s also crucial to do some study and ask a financial expert for guidance.

Refrences:

www.ipleeders.in

www.wallstreetmojo.com

Times of India

www.nism.in

www.taxmann.com