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What are financial securities? Examples, types, and importance

The right kind of financial securities can give investors a regular source of income.

financial securities

A big percentage of the world population generates a regular income from dabbling in various financial instruments. These trading instruments are a safe earning option as the government regulates them and also a great work-from-anywhere option! This is the arena of financial securities.

Right from seasoned investors and big trading houses, even housewives are a part of this vast gamut of earning opportunities. You can be a part of it too, but before you do that, delve into the know-how of financial securities.  

What is security?

The term “security” denotes a negotiable and fungible financial instrument with some monetary value attached. Financial securities refer to traditional and alternative investment certificates such as stocks, derivatives, mutual funds and bonds. They are entry-level derivative financial products that represent evidence of debt or equities that represent ownership in an enterprise. 

The Financial Security Regulation Act (FSRA) of India defines financial securities as any instrument that constitutes or can be converted into a share in a company or which entitles the holder to receive dividends from the company.

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What is financial security?

Financial security is a contract that can be traded on exchanges or over-the-counter (OTC) just like stocks, bonds, and commodities. They give the buyer a right to receive payments from the seller on a pre-decided schedule or event. Financial securities carry certain risks and rewards based on the type of security. 

When multiple and different financial instruments are clubbed together for selling to investors as a package, it is called securitisation. Stocks are generally considered the safest financial security because shareholders get to share the company’s profits through them. 

On the other hand, bonds are deemed riskier because if investors lose money, they have to pay back the bondholders who have purchased it. Financial securities also include commodities such as oil and gold. Although they carry some risks, they also provide positive returns if prices rise.

Types of financial securities

Indian financial markets have three types of financial securities: equity, debt, and hybrids. Each of these has its unique set of benefits and drawbacks. Let’s look at each type of security in detail.

Equity Securities

Equity securities denote the ownership interests in a company. With equity shares, investors can share the company’s profits and losses. The rate of returns is higher than government bonds, depending on the company in which an individual is investing. 

However, equity shares can carry a higher risk than government bonds because stock market fluctuations often affect their values.

Debt Securities

Debt securities are lending commitments between borrowers and lenders. Their rate of return is generally lower than equity securities.

  • Debentures

Debentures are similar to bonds as they offer a rate of interest and a guaranteed return. They are a type of financial security offered by Indian companies and give their holders limited voting rights and access to dividends if the company faces bankruptcy. 

Debentures generally are priced higher than equity shares or government bonds and are thus more valuable in the open market. 

  • Government Bonds 

Debt securities include Government bonds which are national financial securities. The primary advantage of this security is that it offers investors a safe avenue for investing their money. Since a government guarantee backs their worth, a customer is assured that the investment will be repaid regardless of the market conditions. 

However, the downside of government bonds is a lower interest rate than other securities. So although there is a higher level of safety with this financial security, you may not get as high a return on this investment as you would with other options.

Hybrid Securities

Hybrid security combines the attributes of both equity and debt financial securities. They provide the securities holders with company ownership and regular payments through dividends or interests. Examples of hybrid securities are equity warrants, convertible corporate bonds, and preferred shares. 

Each type of financial security has a few benefits but also some risks attached to them. Before picking any investment security, consider your financial goals and needs. 

Also Read: Futures vs. Options: Differences every investor must know!

Regulations governing financial securities

Most countries deploy regulations to protect borrowers and lenders trading in financial services. One of the main reasons why government regulations are put in place for numerous financial services is because they play a significant role in the growth of the economy.

Four primary laws regulate the financial securities market in India: 

  • Securities Contracts (Regulation) Act, 1956 (SCRA)
  • Depositories Act, 1996
  • Companies Act, 2013 
  • SEBI (Securities and Exchange Board of India) Act, 1992

Need for financial securities

While stocks offer investors a share in a company’s profits, bonds offer a return based on the assumption that the issuer of the bonds will repay the financiers in full at a set date. Let’s look at the benefits offered by financial securities. 

  • Hedging tools

Securities can also be used as hedging against the risks of investing in volatile markets. For instance, an individual can buy stocks as part of an investment portfolio and use them as bank loan collateral. Doing this protects the individual from risk by locking in any future profits (decreasing the potential loss) and providing liquidity for future trades.

  • Diversification opportunity

With financial securities, one gets diversification benefits by investing in different types of assets across different sectors and markets. For example, by owning shares in a company and bonds issued by a government entity, an individual can get exposure to different parts of the economy. 

  • Long-term returns

Investment in Financial Securities can help you put aside money for the future. Investing wisely can give long-term growth in the investment in many forms. Different securities generate different levels of returns depending on the investment made.

  • Avoid the effects of inflation 

Investing in financial securities is a good way to protect against inflation’s effects. Your money retains its starting value as it grows over time through profitable investments. Most financial securities are investments that promise a rate of return higher than the rate of inflation.

  • Source of regular income

With dividends, individuals are assured of a consistent income. This regular inflow of money can be further invested to diversify and enhance the investment portfolio. 

Also Read: Understanding the difference between equity and debt IPO for the right investment

Final thoughts

Financial securities provide businesses with a remarkable avenue to generate funds without resorting to loans, presenting an array of advantages.  Investors flock to the financial securities market to gain direct access to a company’s underlying assets, including stocks and bonds, ultimately fueling economic growth and prosperity.

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