What Are Definitive Securities?

Definitive securities are securities issued with a paper certificate. They stand in contrast to book-entry securities, which issuers enter into a computer system. Governments or corporations can circulate definitive securities; however, they are significantly less frequently circulated today than they were before widespread digitization.

Key Takeaways

  • Definitive securities are those that are issued on paper, versus book-entry securities, which are digital-only.
  • Companies and governments circulate these kinds of securities, although their use has lessened in the digital age.
  • Even when definitive securities are issued now, they are normally backed up with a digital version, so as to protect against theft or loss.
  • Bearer bonds, now out of use in the United States, are a type of definitive security, issued on paper and not connected to an investor's name.

Understanding Definitive Securities

Definitive securities have fallen out of favor primarily because of electronic record-keeping. Investors can readily lose paper certificates and they are also prone to theft and fraud, making them a less attractive means of owning a security.

Bearer bonds are a type of definitive security since they are issued in certificate form and not attached to an investor's name. Whoever presents the bond's coupon payments and certificate receives the money owed.

To redeem coupons for bearer bonds, investors formerly had to physically cut the paper coupons and mail them to the issuer for redemption. Investors today see this process as inefficient, a reason why bearer bonds are no longer issued in the U.S., though the primary reason was to prevent fraud.

Even securities issued today with paper certificates are almost always also recorded electronically for the protection of the investor. In case the physical certificate is lost, there is a recorded digital transaction proving the ownership of the security.

Registered bonds are also considered definitive securities, though they are attached to the purchaser's name. Thus, only the person in whose name the bond is registered can redeem the bond, regardless of who presents the bond certificate.

Definitive Securities as Bearer Bonds Today

Bearer bonds were last issued in the United States in 1982 after the Tax Equity and Fiscal Responsibility Act (TEFRA) imposed penalties against their issuers and buyers. The act effectively put an end to these types of bonds.

Because bearer bonds were not attached to an investor's name, they provided a way for people to invest, and therefore accumulate money anonymously. This practice allowed for tax fraud and evasion on the part of the investor.

However, you can still purchase bearer bonds in countries outside of the U.S. For example, Eurobonds are a favorite type of bearer bond that allows foreign citizens to invest their money in a company or government of another country. Interestingly, neither the investor nor the issuer has to be in Europe or use the euro, as the name would seem to imply.

Real-World Example of Bearer Bond

In 2014, Apple issued a Eurobond, through which the company raised 2.8 billion euros. This was the first time that Apple issued debt in a currency that was not the U.S. dollar.

The primary reason it did this was because of the lower borrowing costs in Europe; meaning that Apple would have to pay lower coupon payments to the bondholders. The two tranches that the bonds came in paid a coupon of 1% and 1.6%.

The debt was rated AA and in high demand, leading financial analysts to believe that other companies may decide to issue debt in euros due to the better rates. Apple, a few months prior, had also issued debt to buy back shares rather than having to utilize its large cash reserves to do so. Using cash would have resulted in tax charges that Apple was able to avoid.

While some may see the buying of these bonds as a way for investors to avoid paying taxes at home, investments in bearer bonds remain legal. Furthermore, companies issuing these types of bonds may pay lower yields than they would have to pay at home, in the case of Apple. A company can obtain this lower yield by choosing to issue its bonds in a country with interest rates that are currently lower than in their home country, which is a smart business strategy.