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.
Types of Marketable 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, and so investing in the stock market can be a risky move. However, many people make a very good living investing in equities, using short- and long-term strategies.
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 a like a bank loan, a bond guarantees a fixed rate of return, called the coupon rate, in exchange for 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 (referred to as the discount) or for more than par (also called the premium), depending on their current market values. Coupon payments are based on the par value of the bond rather than its market value or purchase price, and so an investor who can purchase a bond at a discount still enjoys the same interest payments as an investor who purchases 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. Preference shares, also called preferred shares, have the benefit of a fixed dividend, much like a bond.
Unlike a bond, however, 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 issuing company goes bankrupt and must liquidate assets to pay off its liabilities.
In exchange, preferred shareholders give up the voting rights that ordinary shareholders enjoy. The guaranteed dividend and insolvency safety net make preference shares a more enticing investment to those who find the common stock market too risky but don't want to wait around for bonds to mature.
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.
Derivatives are investments directly dependent on the value of other securities. In the last quarter of the 20th century, derivatives trading began growing exponentially. Many types of derivatives can be considered marketable, such as futures, options and rights and warrants.
The most reliable liquid securities fall in the money market category. Most money market securities act as short-term bonds and are purchased in huge quantities by large financial entities. These include Treasury bills (T-bills), banker's acceptances, purchase agreements and commercial paper.
Common Characteristics of Marketable Securities
The overriding characteristic of marketable securities is their liquidity, or the ability to convert them into cash and use them as an intermediary in other economic transactions. A security is further made liquid by its relative supply and demand in the market and the volume of its transactions. Because marketable securities have short maturities, and can be sold easily with price quotes available instantly, they typically have a very low rate of return, paying less interest than other instruments. But they are usually perceived as low-risk as well.
From a liquidity standpoint, investments are marketable when they can be bought and sold easily. If an investor or a business needs some cash in a pinch, it is much easier to enter the market and liquidate common stock than, say, 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, the marketable security 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 and Working Capital
In accounting terminology, marketable securities are classified as current assets, and, therefore, are often included in the working capital calculations on corporate balance sheets. (It is often noted if they are not; the definition of adjusted working capital, for example, considers only operating assets and liabilities, excluding any financing-related items, such as short-term debt and marketable securities.) Businesses that have conservative cash management policies tend to invest in marketable securities instead of long-term or riskier securities, such as stocks and other 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 at the current assets section.
An investor who analyzes a company may wish to carefully study the company's announcements that make certain cash commitments, such as dividend payments before they are declared. For a company that is low on cash and has all its balance tied in marketable securities, an investor may exclude the cash commitments that management announced from its marketable securities, since this portion of marketable securities is earmarked and spent on something other than paying off current liabilities.
The Bottom Line
It's important to note that there are liquid assets that are not securities, and there are securities that are not liquid assets. Every marketable security must still satisfy the requirements of being a financial security: It must represent interest as an owner, creditor or rights to ownership, carry an assigned monetary value, and be able to provide a profit opportunity for the purchaser.