This page contains some quick notes on some research into how trading markets work.
A security is any tradable asset, generally classified into:
|Debt||Any form of loan, such as bonds and debentures.|
|Equity||Stocks which imply partial ownership of a business.|
|Derivatives||Instruments which derive their value from other assets, having no intrinsic value themselves.|
Typically the holder of a debt security has lent capital to the issuer of the security, and is entitled to the payment of a principle1) as well as interest after the maturity of the bond, and potentially other privileges as specified in the agreement.
In the case of bankruptcy of the issuer, holders of debt securities typically get repaid from the remaining assets of the issuer before holders of equity securities.
Some examples of types of bond:
|Corporate bonds||The debt of commercial entities, either as long-term (~10 years) debentures or shorter-term commercial paper2).|
|Government bonds||Long-term bonds issued by governments to fund public spending. Typically long-term and low-interest, historically considered low risk.|
|Municipal bonds||Similar to government bonds, but issued by a smaller government unit, such as a city council.|
|Supranational bonds||The debt of entities spanning multiple sovereign states, such as the World Bank and IMF.|
Typically common stock, which represents a simple proportion of the ownership of the issuing entity. Unlike debt securities there is typically no obligation for regular payments to the holder of the security, and debt securities are typically repaid first in the case of bankruptcy of the issuer. Conversely stock typically carries voting rights and the potential for increases in value if the issuer performs well.
Some securities combine elements of debt and equity securities. Some examples:
|Preference shares||Similar to common stock, but at a higher repayment priority than standard shareholders in case of bankruptcy, although still typically behind bonds in the queue.|
|Convertibles||Bonds that can be converted at a later point to common stock, whenever the holder feels the price is optimal. If it is a callable bond then the holder has a fixed period in which to convert, after which the issuer can pay back a fixed amount (typically higher than the principle) to cancel the bond instead of issuing the holder with stock.|
|Warrants||Similar in principle to options, gives the holder the right to purchase a specified number of shares at a specified price within a defined period.|
There are two types of derivative security:
|Over The Counter (OTC)||Privately traded without using an exchange.|
|Exchange Traded (ETD)||Traded through a specialised derivatives exchange or a standard exchange.|
In general, they are used for a variety of purposes:
|Hedging||Mitigate the risk in another transaction by taking out a derivative in the opposite direction.|
|Options||Where the value of the derivative is linked to the underlying asset reaching a specific price, or other event.|
|Non-tradable Assets||Assign notional value to assets which can't otherwise be traded (e.g. weather derivatives).|
|Leverage||Amplify the effect of changes in the price of the underlying asset. For example, using capital as margin on which to borrow a larger sum to trade in higher volumes.|
|Speculation||Make profits based on the specified asset price behaving in an anticipated fashion.|