Chapter 1: What is a Security? - A. Introduction: What is a Security?
What Is a Security?
A security is any investment product that can be exchanged for value and involves risk. In order for an investment to be considered a security it must be readily transferable between two parties and the owner must be subject to the loss of some or all of their invested principal. If the product is not transferable or does not contain risk it is not a security.
|Types of Securities||Types of Non-Securities|
|Common & Preferred stock||Whole life insurance|
|Bonds||Term life insurance|
|Mutual funds||Retirement plans|
|Variable annuities||Fixed annuities|
|Variable life insurance||Prospectus|
Securities are broken up into two major categories for the Series 99: equity and debt. Let’s begin by comparing the two different types of securities:
Equity = Stock
The term equity is synonymous with the term stock. Throughout your preparation for this exam and on the exam itself, you will find many terms that are used interchangeably. Equity or stock creates an ownership relationship with the issuing company. Once an investor has purchased stock in a corporation, they become an owner of that corporation. The corporation sells off pieces of itself to investors in the form of shares in an effort to raise working capital. Equity is perpetual, meaning there is no maturity date for the shares and the investor may own the shares until they decide to sell them. Most corporations use the sale of equity as their main source of business capital.Debt = Bonds
A bond, or any other debt instrument, is actually a loan to the issuer. By purchasing a bond, the investor has made a loan to the corporation and become a creditor of the issuing company.
Debt instruments, unlike their equity counterparts, have a time frame or maturity date associated with them. Whether it is one year, five years, or 30 years, at some point the issue will mature and the investor will receive their principal back and will cease to be a creditor of the corporation. We will examine how investors may purchase stocks and bonds, but first we must look at how the corporation uses the sale of these securities to meet their organizational goals.
The term capitalization refers to the sources and makeup of the company’s financial picture. To determine a company’s capital composition, an investor must look at the corporation’s balance sheet. The balance sheet is like a snapshot of the corporation’s finances at the time it was produced. It shows a list of the company’s assets and liabilities as well as the company’s net worth or stockholders’ equity. Most publicly traded companies have to disclose or report their performance at least quarterly.
The Balance Sheet Equation
assets – liabilities = net worth
Assets are everything that a company owns, including cash, securities, investments, inventory, property, and accounts receivable.
Liabilities are everything that a company owes, including accounts payable and both long- and short-term debt as well as any other obligations.
The company’s net worth is equal to the value of all assets after all liabilities have been paid. This corporation’s net worth is the stockholders’ equity. Remember that the stockholders own the company.
There are thousands of companies whose stock trades publicly and that have used the sale of equity as a source of raising business capital. All publicly traded companies must issue common stock before they may issue any other type of equity security. There are two types of equity securities, common stock and preferred stock. While all publicly traded companies must have sold or issued common stock, not all companies may want to issue or sell preferred stock. Let’s take a look at the creation of a company and how common stock is created.
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