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generalnotes:securities_and_trading

Notes - Securities and Trading

This page contains some quick notes on some research into how trading markets work.

Securities

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.

Debt

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.

Equity

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.

Hybrid Securities

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.

Derivatives

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.
1) The original loan amount.
2) Essentially a post-dated cheque with a maturity of no more than 270 days.
generalnotes/securities_and_trading.txt · Last modified: 2013/05/30 16:17 by andy