This article has been written by Dhruv Mathur pursuing a Diploma in Law Firm Practice: Research, Drafting, Briefing, and Client Management. This article has been edited by Tanmaya Sharma (Associate, Lawsikho) and Ruchika Mohapatra (Associate, Lawsikho).
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
“Securities” refers to substitutable and tradable financial instruments with a particular monetary value. This represents the ownership of a listed company through its shares. The legal entity’s bonds represent creditor relationships with government agencies or businesses or optional ownership.
For laymen, securities are financial assets of monetary value that investors use to invest in a company, while companies use them to raise capital. In India, securities are defined under the Securities Contracts (Regulatory) Act of 1956. Under Section 2 (h), securities include “shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporates. Companies Act 2013 also refers to the exact definition, and under Section 2 (81), securities have the same meaning as defined above.
Many who wonder what security is are probably not already aware of this asset class. The most common examples are stocks and bonds. In addition to commodities, securities offer investors the opportunity to increase the value of their money. The value of securities can fluctuate due to various factors. Securities can be broadly divided into four types based on their function and operation. These four types are equity securities, debt securities, derivative securities, and hybrid securities.
Equity securities
Equity securities represent the ownership of shareholders of a company (company, partnership, or trust). They are realized in the form of equity capital shares, including both common stock and preferred stock. Equity securities holders are usually not entitled to regular payments. In contrast, equity securities often pay dividends but benefit from capital gains (if their value increases) when the securities are sold, they may receive it. Equity Securities gives holders some control over the company through voting rights. In the event of bankruptcy, they will only receive a portion of the remaining interest after all debt has been repaid to the creditor. It may also be provided as a payment method.
To calculate the shares of a company, you need to divide the number of shares owned by the company by the total number of shares of the company and multiply by 100. The advantage of investing in equity securities is virtually no risk of default for the company. Their profit or loss corresponds to the ownership they exercise in the company.
Equity securities can increase or decrease in value depending on the company’s performance and the financial markets.
Debt securities
Debt securities represent borrowings that need to be repaid and are subject to conditions that determine the loan’s size, interest rate, and due date or renewal date. Debt securities, including government bonds, corporate bonds, certificates of deposit (CD), and collateralized debt obligations (such as CDOs and CMOS), typically pay the regular holder interest and repay the principal (regardless of the issuer). Give the right. `Performance) Furthermore, all other contractually agreed rights (not including voting rights) and usually issued for some time, after which the issuer can repay. Debt securities can be secured (backed by collateral) or unsecured, and with collateral, they can be contractually prioritized over other unsecured subordinated bonds in the event of bankruptcy.
The mechanism of this bond is to issue a bond of a specific value with a period in which the company promises to pay the amount specified in the bond. The value that a company promises to pay later is usually higher than the value of the bonds offered and gives investors an incentive to buy the bonds. Bonds are called zero-coupon bonds or bonds, depending on whether the bond is sold below par or at par, but the increase in value is based on interest.
Let us look at an example. If the school district wants to build a new school, it can issue a loan to fund the project. Investors who buy bonds borrow money from the school district, hoping to be repaid through interest. This scheme is suitable for both investors and bond issuers. Bonds are less volatile than stocks and help balance the investment portfolio. Companies that issue bonds also receive loans to meet their financial needs.
Derivatives securities
It is a financial instrument whose value depends on another underlying financial instrument or another underlying promise or contract. It is called a derivative because its value is derived from another promise, contract, or financial instruments such as a stock or bond. In the past, derivatives have been used to ensure a balanced exchange rate for internationally traded commodities. International traders needed an accounting system to lock various home currencies at a particular exchange rate. Swaps, futures contracts, and options are examples of derivative securities.
Apart from these three kinds of securities, there is also a fourth kind of security used which does not fall into any of the heads mentioned above because of its nature, called hybrid security.
Hybrid securities
As the name implies, hybrid securities are a combination of some of the characteristics of debt and capital. Examples of hybrid securities are warrants (an option that gives shareholders the right to buy shares at a specified price within a specified time), convertible bonds (corporate bonds that can be converted into the issuer’s common stock), and preferred stock. Shares of a company where payments of interest, dividends, or other capital interests may take precedence over overpayments of other shareholders.
These are defined under Section 2 (19A) of the Companies Act, 1956 as “any security which has the character of more than one type of security, including their derivatives” These are hence called ‘hybrids’ because they have mixed characteristics of both equity and debt.
The Supreme Court dealt with the issue of whether ‘hybrid’ securities are ‘securities’ as per the scheme of the Companies Act and SEBI Act in the case of Sahara India Real Estate Corporation Limited & Ors. v. SEBI
In this case, the Supreme Court held that ‘hybrid securities’ are securities within the meaning of the Companies Act, Securities Contracts Regulation Act and hence the SEBI Act.
It based its decision on the fact that Section 2 (h) of the Securities Contracts Regulation Act, 1956 defines securities to include “shares, scrips, stocks, bonds, debenture stocks, or other marketable securities of like nature in or of any incorporated company or other body corporate” and that the term ‘hybrids’ has been defined as ‘any security having the character of more than one type of security and since these securities are ‘marketable’ they would fall within the meaning of securities for Companies Act, Securities Contracts Regulation Act and the SEBI Act.
Examples of hybrid securities are preferred stock that allows holders to receive dividends before holders of common stock, convertible bonds that can be converted to a known number of shares during the bond’s life or at the maturity date of the contract and so on. Hybrid securities are a complex product. Even experienced investors can find it challenging to understand and assess the risks associated with a transaction. Institutional investors may not understand the terms and conditions of the transactions they enter into when purchasing hybrid securities.
Securities trading
Listed securities are listed on the stock exchange, and issuers can attract investors by seeking a listing of securities and providing a liquid and regulated trading market. In recent years, informal electronic trading systems have become commonplace, and securities are often traded “over-the-counter” or directly between investors online or over the phone. An initial public offering (IPO) is the company’s first extensive public offering of shares.
After the IPO, each newly issued share still on sale in the primary market is called a secondary offering. Alternatively, securities can be personally offered to a restricted qualified group as part of a so-called private placement. This is a significant difference in both corporate law and securities supervision. Companies may sell shares in a combination of public and private placements. In the secondary market, also known as the aftermarket, securities are transferred from one investor as an asset to another.
Shareholders can sell securities to other investors for cash or capital gains. Therefore, the secondary market complements the primary market. Private placements are less liquid because the secondary market is not publicly tradable and can only be transferred between qualified investors.
Regulation of securities
In the United States, the Securities and Exchange Commission (SEC) publicly offers and sells securities. Public offerings, sales, and transactions of US securities must be registered and submitted with the SEC’s State Securities Division. Self-regulatory bodies (SROs) within the securities industry also often take a regulatory position. Examples of SROs are the National Association of Securities Dealers (NASD) and the Financial Industry Regulatory Authority (FINRA). The Supreme Court defined offering for securities in the 1946 case known as SEC v. W.J. Howey Co. In its judgment, the court derives the definition of securities based on four criteria: the existence of an investment contract, the establishment of a joint venture, the promise of profits by the issuer, and the use of a third party to facilitate the offer.
Investing in securities
A company that sells securities is called an issuer, and the person who buys it is, of course, an investor. In general, securities are investments and means that local governments, businesses, and other commercial enterprises can raise new capital. Companies can make a lot of money public, for example, by selling their shares in an initial public offering (IPO). City, state, or district governments can raise funds for specific projects by issuing local government loans. Depending on market demand and the price structure of financial institutions, securities financing may be preferable to bank loan financing.
On the other hand, buying securities with borrowing, called margin trading, is a popular investment method. In essence, a company can offer property rights in the form of cash or other securities early or late in payment to settle debts or other obligations to other companies. These collateral arrangements have increased recently, especially among institutional investors.
Other securities
Certified securities
Certified securities are presented in the form of physical paper. Securities can also be held through a direct registration system that records shares. In other words, the transfer agent manages the shares on behalf of the company without a physical certificate.
Bearer securities
A bearer security is tradable security and gives shareholders the rights that arise from the security. They are transferred from investor to investor, in some cases by endorsement and delivery. Concerning ownership, bearer securities prior to digitization were always split. Each security represents a separate asset that is legally separated from the other securities on the same issue.
Registered securities
The registered documents will include the owner’s name and any other required information registered by the issuer. Registered papers will be transferred by changing the registration. Registered bonds are not always split. NS. The whole problem forms a single asset, and each security becomes part of the whole. Unsplit securities are essentially substitutable. The share of the secondary market is not always divided.
Conclusion
Securities are a financial instrument used by companies to raise capital. There are various types of securities in the capital market: Equity, Debt, Derivatives, and Hybrid. Hybrid Security is a relatively new concept that is getting popular because of its many advantages. Primary capital markets are where new securities are issued and sold. The secondary market is where previously issued securities are traded between investors. The Indian Securities and Exchange Board (SEBI) regulates the capital market in India.
References
- https://www.investopedia.com/terms/s/security.asp
- https://blog.ipleaders.in/5-different-types-of-hybrid-securities-and-their-features/
- https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/types-of-security/
- https://www.masterclass.com/articles/what-are-securities#4-types-of-securities
- https://www.wealthsimple.com/en-ca/learn/what-are-securities
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