Marketable securities are investments that can easily be bought, sold, or traded on public exchanges. The high liquidity of marketable securities makes them very popular among individual and institutional investors. These types of investments can be debt securities or equity securities.
- Stocks, bonds, preferred shares, and ETFs are among the most common examples of marketable securities.
- Money market instruments, futures, options, and hedge fund investments can also be marketable securities.
- The overriding characteristic of marketable securities is their liquidity.
- There are liquid assets that are not marketable securities, and there are marketable securities that are not liquid assets.
- Every marketable security must still satisfy the requirements of being a financial security.
Types of Marketable Securities
Stocks as Securities
Stock represents an equity investment because shareholders maintain partial ownership in the company in which they have invested. The company can use shareholder investment as equity capital to fund the company's operations and expansion.
In return, the shareholder receives voting rights and periodic dividends based on the company's profitability. The value of a company's stock can fluctuate wildly depending on the industry and the individual business in question, so investing in the stock market can be a risky move. However, many people make a very good living investing in equities.
Bonds as Securities
Bonds are the most common form of marketable debt security and are a useful source of capital to businesses that are looking to grow. A bond is a security issued by a company or government that allows it to borrow money from investors. Much like a bank loan, a bond guarantees a fixed rate of return, called the coupon rate, in exchange for the use of the invested funds.
The face value of the bond is its par value. Each issued bond has a specified par value, coupon rate, and maturity date. The maturity date is when the issuing entity must repay the full par value of the bond.
Because bonds are traded on the open market, they can be purchased for less than par. These bonds trade at a discount. Depending on current market conditions, bonds may also sell for more than par. When this happens, bonds are trading at a premium. Coupon payments are based on the par value of the bond rather than its market value or purchase price. So, an investor who purchases a bond at a discount still enjoys the same interest payments as an investor who buys the security at par value.
Interest payments on discounted bonds represent a higher return on investment than the stated coupon rate. Conversely, the return on investment for bonds purchased at a premium is lower than the coupon rate.
There is another type of marketable security that has some of the qualities of both equity and debt. Preferred shares have the benefit of fixed dividends that are paid before the dividends to common stockholders, which makes them more like bonds. However, bondholders remain senior to preferred shareholders. In the event of financial difficulties, bonds may continue to receive interest payments while preferred share dividends remain unpaid.
Unlike a bond, the shareholder's initial investment is never repaid, making it a hybrid security. In addition to the fixed dividend, preferred shareholders are granted a higher claim on funds than their common counterparts if the company goes bankrupt.
In exchange, preferred shareholders give up the voting rights that ordinary shareholders enjoy. The guaranteed dividend and insolvency safety net make preferred shares an enticing investment for some people. Preferred shares are particularly appealing to those who find common stocks too risky but don't want to wait around for bonds to mature.
Exchange-Traded Funds (ETFs)
An exchange-traded fund (ETF) allows investors to buy and sell collections of other assets, including stocks, bonds, and commodities. ETFs are marketable securities by definition because they are traded on public exchanges. The assets held by exchange-traded funds may themselves be marketable securities, such as stocks in the Dow Jones. However, ETFs may also hold assets that are not marketable securities, such as gold and other precious metals.
Other Marketable Securities
Marketable securities can also come in the form of money market instruments, derivatives, and indirect investments. Each of these types contains several different specific securities.
The most reliable liquid securities fall in the money market category. Most money market securities act as short-term bonds and are purchased in vast quantities by large financial entities. These include Treasury bills, banker's acceptances, purchase agreements, and commercial paper.
Many types of derivatives can be considered marketable, such as futures, options, and stock rights and warrants. Derivatives are investments directly dependent on the value of other securities. In the last quarter of the 20th century, derivatives trading began growing exponentially.
Indirect investments include hedge funds and unit trusts. These instruments represent ownership in investment companies. Most market participants have little or no exposure to these types of instruments, but they are common among accredited or institutional investors.
Features of Marketable Securities
The overriding characteristic of marketable securities is their liquidity. Liquidity is the ability to convert assets into cash and use them as an intermediary in other economic activities. The security is further made liquid by its relative supply and demand in the market. The volume of transactions also plays a vital part in liquidity. Because marketable securities can be sold quickly with price quotes available instantly, they typically have a lower rate of return than less liquid assets. However, they are usually perceived as lower risk as well.
There are liquid assets that are not marketable securities, and there are marketable securities that are not liquid assets.
From a liquidity standpoint, investments are marketable when they can be bought and sold quickly. If an investor or a business needs some cash in a pinch, it is much easier to enter the market and liquidate marketable securities. For example, common stock is much easier to sell than a nonnegotiable certificate of deposit (CD).
This introduces the element of intent as a characteristic of "marketability." And in fact, many financial experts and accounting courses claim intent as a differentiating feature between marketable securities and other investment securities. Under this classification, marketable securities must satisfy two conditions. The first is ready convertibility into cash. The second condition is that those who purchase marketable securities must intend to convert them when in need of cash. In other words, a note purchased with short-term goals in mind is much more marketable than an identical note bought with long-term goals in mind.
Marketable Securities in Accounting
In accounting terminology, marketable securities are current assets. Therefore, they are often included in the working capital calculations on corporate balance sheets. It is usually noted if marketable securities are not part of working capital. For example, the definition of adjusted working capital considers only operating assets and liabilities. This excludes any financing-related items, such as short-term debt and marketable securities.
Businesses that have conservative cash management policies tend to invest in short-term marketable securities. They avoid long-term or riskier securities, such as stocks and fixed-income securities with maturities longer than a year. Marketable securities are typically reported right under the cash and cash equivalents account on a company's balance sheet in the current assets section.
An investor who analyzes a company may wish to study the company's announcements carefully. These announcements make specific cash commitments, such as dividend payments, before they are declared. Suppose that a company is low on cash and has all its balance tied up in marketable securities. Then, an investor may exclude the cash commitments that management announced from its marketable securities. That portion of marketable securities is earmarked and spent on something other than paying off current liabilities.
The Bottom Line
There are liquid assets that are not marketable securities, and there are marketable securities that are not liquid assets. For example, a recently minted American Eagle Gold Coin is a liquid asset, but it is not a marketable security. On the other hand, a hedge fund may be a marketable security without being a liquid asset. Every marketable security must still satisfy the requirements of being a financial security. It must represent interest as an owner or creditor, carry an assigned monetary value, and be able to provide a profit opportunity for the purchaser.