Why Are Financial Assets Also Called Securities?

Financial assets are broadly defined as investment holdings that derive their value from a contractual claim. When these assets are offered for public trading, they are referred to as securities. This article will delve into the reasons why financial assets are termed as securities, explore the types of securities, and discuss the role of securities in financial markets.

What Are Financial Assets?

Financial assets can be categorized into two main types: equity and debt. Equity represents ownership in a company and provides a claim to its profits and assets. Debt, on the other hand, represents a loan made to a borrower, such as a company or government, with the promise of regular interest payments and the return of principal.

What Are Securities?

Securities are a specific type of financial asset that can be bought or sold in financial markets. These assets are fundamentally a claim on the assets or earnings of a company or government entity. Securities are essential components of modern financial markets, providing a means for individuals and institutions to invest in companies and governments, as well as to manage risk and diversify their portfolios.

Why Are Financial Assets Called Securities?

Financial assets are called securities because they represent a contractual claim on the assets or earnings of a company or government entity. When an investor purchases a security, they are effectively buying a piece of the issuing entity. This gives the investor a right to a portion of the entity's assets or earnings, dependent on the type of security.

For instance, when an investor buys a share of stock in a company, they obtain a piece of ownership in that company, entitling them to a portion of the company's profits and assets, as well as the right to vote on significant company decisions. Alternatively, when an investor buys a bond issued by a government or company, they are making a loan to that entity and are entitled to regular interest payments and the return of their principal at the end of the bond term.

The Role of Securities in Financial Markets

Securities markets are vital for raising capital as companies and governments issue securities to investors to finance their operations and projects. They also provide a platform for investors to buy and sell securities, adjusting their portfolios according to changing investment goals and risk tolerance. Additionally, securities markets help determine the prices of securities based on supply and demand, and provide a means for investors to hedge their risks through options and futures contracts.

Different Types of Securities

There are several types of securities available for investors to buy and sell in financial markets, each with its unique characteristics and risks. Some of the most common types include:

Stocks: Represent ownership in a company and provide a claim to its profits and assets. Bonds: Represent a loan made to a borrower, such as a government or company, with the promise of regular interest payments and the return of principal. Mutual Funds: Investment vehicles that pool money from many investors and use it to buy a portfolio of securities. Investors own shares in the fund and are entitled to a portion of the fund's earnings. Exchange-Traded Funds (ETFs): Similar to mutual funds, but traded on an exchange like individual stocks with fluctuating prices throughout the day. Options: Contracts that give the holder the right, but not the obligation, to buy or sell a security at a specific price at or before a certain date. Futures: Agreements to buy or sell a particular asset at a future date and price.

Investors must carefully consider their investment goals and risk tolerance when selecting which securities to invest in, as each type of security carries its own unique characteristics and risks.

Conclusion

Financial assets are termed securities because they represent a claim on the assets or earnings of a company or government entity. Securities are critical components in modern financial markets, allowing individuals and institutions to invest in companies and governments, manage risk, and diversify their portfolios. Understanding the various types of securities and their roles is crucial for achieving financial success and mitigating risks.