What Are Securities? Definition, Types, and Examples

Search Fintrev

Search our guides, reviews and glossary.

Securities are tradable financial instruments that represent an ownership stake, a creditor relationship, or a right to an asset or payment stream. Corporations, governments and other entities issue them to raise capital, and investors buy them for income, growth or protection against other risks. Stocks, bonds, Treasury bills, options and mortgage-backed bonds are all securities, but the U.S. legal definition is wider than any list of familiar instruments. Under federal law, an arrangement can be a security because of how it is structured, even with no stock certificate and no bond.

What Is a Security?

A security is a financial instrument that can be bought, sold or transferred and that represents a defined financial interest. That interest takes one of three basic forms:

1. Ownership. A share of stock makes the holder a part-owner of a company, with a claim on its residual value and often a vote.
2. Debt. A bond or note makes the holder a lender. The issuer owes interest and must repay the principal on agreed terms.
3. A contractual right. An option, a warrant or an asset-backed note gives the holder a right whose value comes from another asset, a pool of loans or a future event.

The entity that creates and sells a security is the issuer. Issuers include public and private companies, partnerships, trusts, the federal government, government agencies, and state, city and county governments. The buyers are investors: individuals, pension funds, mutual funds, insurers, banks and other institutions.

How Securities Work

A security turns a financing need into a standardized claim that many investors can hold and trade. A company that needs $50 million could borrow it from one bank, or it could sell 50,000 bonds at $1,000 each or issue new shares. Those routes spread the claim across many investors, who can later trade it without the issuer’s involvement. Depending on demand and pricing, this can cost less than a bank loan, but it brings disclosure obligations and offering costs.

U.S. federal regulation of securities began with the Securities Act of 1933, which requires anyone offering securities to the public to disclose information about the offering, the issuing company and its principal officers and directors, to protect investors from misleading or deceptive sales practices. The issuer is strictly liable for material misstatements in its registration statement, whether or not the error was intentional, and directors, officers and underwriters can also be held liable. The Securities Exchange Act of 1934 created the SEC to write and enforce rules and extended regulation to secondary-market trading, exchanges and brokers.

Neither law limits “security” to stocks and bonds. The statutes list many instruments, including notes, stock, bonds, debentures and certificates of interest. The list also contains the catch-all term “investment contract,” and that term has driven much of the legal history.

The Howey Test

In SEC v. W.J. Howey Co. (1946), the Supreme Court considered a Florida company that sold plots of citrus grove land together with a service contract under which the company cultivated the trees and marketed the fruit. Buyers had no stock and no bond, yet the Court held that the arrangement was an investment contract and therefore a security. The case produced a four-part test. An arrangement is a security if it involves:

1. An investment of money,
2. In a common enterprise,
3. With an expectation of profit,
4. Derived from the efforts of a promoter or third party.

Form does not matter under this test. The offering does not need a written contract, a certificate or the word “security.” Courts have applied securities law to interests in whiskey, beavers and chinchilla breeding programs, and the SEC has used the same framework in enforcement actions against issuers of cryptocurrencies and non-fungible tokens. Once an asset is found to be a security, its sellers must register the offering or qualify for an exemption, and anti-fraud rules apply.

Types of Securities

Most securities fall into two broad classes, equity and debt. Hybrid securities combine features of both, and derivatives and asset-backed securities are usually treated as further categories because their value comes from something outside the instrument itself.

Equity securities

An equity security represents an ownership interest in an entity such as a corporation, partnership or trust. The most familiar form is capital stock, which comes as common stock and preferred stock.

Holders of equity are not promised regular payments. Many companies pay dividends, but a board can reduce or stop them. The main return for many shareholders comes from capital gains, the increase in a share’s price that they realize when they sell. Common shareholders usually get voting rights in proportion to the number of shares they own. They use those votes to elect directors and approve major corporate actions.

Ownership also carries the weakest claim if the company fails. In a bankruptcy, shareholders receive only the residual interest, meaning what is left after creditors, including bondholders, have been paid. That position makes equity riskier than debt issued by the same company. Equity can also be issued as payment-in-kind, for example as part of the price in an acquisition.

Debt securities

A debt security represents borrowed money that must be repaid. Its terms set the principal amount, the interest rate (the coupon), the payment schedule and the maturity date. Examples include government bonds, corporate bonds, municipal bonds and certificates of deposit, as well as collateralized structures such as collateralized debt obligations (CDOs) and collateralized mortgage obligations (CMOs).

A debt holder is entitled to interest and repayment of principal under the contract, whatever the issuer’s profits. Debt securities usually carry no voting rights. Most are issued for a fixed term and are repaid or redeemed at maturity. Some can be called early by the issuer.

Debt can be secured by collateral or unsecured. Secured debt is backed by specific assets and usually ranks ahead of unsecured and subordinated debt in a bankruptcy. Unsecured bonds (often called debentures) rely on the issuer’s general creditworthiness.

Labeled hypothetical: a bond with a $1,000 face value and a 5% annual coupon pays $50 of interest a year ($1,000 × 5%) and returns the $1,000 at maturity. Those payments are fixed by contract. The bond’s market price can still move above or below $1,000 as interest rates and the issuer’s credit outlook change.

Hybrid securities

Hybrid securities mix debt and equity features. Common examples:

• Convertible bonds pay interest like ordinary bonds but can be exchanged for a set number of the issuer’s common shares.
• Equity warrants are options issued by the company itself. They give the holder the right to buy shares at a specified price within a specified period.
• Preference (preferred) shares have dividends or other payments that rank ahead of those on common stock.

Preferred stock is legally equity, but it often behaves like a bond. Many preferred shares pay a fixed dividend rate, have limited or no voting rights and rank above common stock in liquidation, so income-focused investors often treat them as fixed-income holdings. They still rank behind the company’s debt, and a missed preferred dividend is not a default the way a missed bond payment is.

Derivative securities

A derivative is a contract whose price depends on the value of an underlying asset, such as a stock, bond, commodity, currency or index. Options are the best-known example: a call option gains value when the underlying asset rises, and a put option gains value when it falls. Futures, forwards and swaps are also derivatives. In the U.S., exchange-listed options and some other derivatives are regulated as securities, while many futures contracts fall under commodities regulation. Derivatives are used both to hedge existing exposure and to take leveraged positions.

Asset-backed securities

An asset-backed security (ABS) represents a share of a pool of income-producing assets, such as auto loans, leases, credit card receivables or mortgages. Payments from the borrowers in the pool are collected and passed to investors over time. Mortgage-backed securities are the largest-known subset. Pools are often divided into tranches with different priority, so senior tranches are paid first and junior tranches absorb losses first.

How Securities Are Issued and Traded

Primary market: IPOs, follow-on offerings and private placements

The primary market is where securities are created and sold for the first time, with the money going to the issuer. A company’s first sale of stock to the public is its initial public offering (IPO). Later sales of new stock to the public are called secondary or follow-on offerings. Governments use the primary market too: the U.S. Treasury sells bills, notes and bonds at auction, and a city might float a municipal bond issue to pay for a school or a water system.

Not every offering is public. In a private placement, securities are sold to a restricted group of investors, typically institutions and individuals who meet legal tests for wealth or sophistication. Relying on exemptions from full SEC registration reduces cost and disclosure but limits who can buy and resell the securities.

Secondary market: exchanges and OTC

Once issued, securities change hands in the secondary market (also called the aftermarket). Here investors trade with each other, and the issuer receives nothing from the trade. A shareholder who sells 100 shares on an exchange gets cash from another investor, not from the company.

Publicly traded securities are commonly listed on exchanges such as the New York Stock Exchange and Nasdaq, which give investors a regulated, liquid place to trade and require companies to meet listing standards. Many securities, including most bonds, trade over the counter (OTC), directly between dealers and investors through electronic networks or by phone.

The secondary market lets an investor exit a 30-year bond in year three, or sell a stock without waiting for the company to buy it back. Privately placed securities have much thinner secondary markets because they can be transferred only to qualified buyers and only under specific conditions.

Buying on margin and using securities as collateral

Investors can buy securities partly with money borrowed from their broker, a practice called buying on margin. The purchased securities serve as collateral for the loan. Margin increases both gains and losses, and a drop in the account’s value can trigger a margin call that requires more cash or forces a sale. Institutions also pledge securities as collateral, heavily so in securities lending and repurchase agreements.

Worked Example: How a Convertible Security Changes Earnings Per Share

Convertible bonds, convertible preferred stock, warrants and similar instruments are sometimes called residual securities, because they can turn into common stock. Companies may offer them when competition for funds is intense, since the conversion option makes the instrument more appealing to buyers.

When these instruments convert or are exercised, the number of shares outstanding rises. Each existing share then represents a smaller slice of the company. This is dilution, and it shows up directly in earnings per share (EPS).

Labeled hypothetical, with stated assumptions:

• A company has 10 million common shares outstanding and $20 million of annual net income.
• EPS before conversion: $20,000,000 ÷ 10,000,000 = $2.00.
• The company has convertible bonds outstanding that convert into 2 million new shares.
• Assume, for simplicity, that net income stays at $20 million after conversion. In practice, the company would also stop paying interest on the converted bonds, which would raise net income somewhat.
• EPS after conversion: $20,000,000 ÷ 12,000,000 = about $1.67.

Earnings did not change, but each share now claims about 17% less of them. Because valuation measures such as the P/E ratio divide price by EPS, analysts often look at “diluted” EPS, which counts the shares that convertibles and options could create.

How Securities Are Held and Recorded

Certificated securities are represented by physical paper certificates. They were once standard but have largely been replaced by book-entry form. Under the direct registration system, a transfer agent records shares in the owner’s name on the issuer’s behalf, with no paper certificate. For shares held through brokers, an issuer can deposit a single global certificate covering an entire issue with the Depository Trust Company (DTC), and all trading through DTC takes place electronically. The form does not change the holder’s rights or the issuer’s obligations.

Registered securities carry the holder’s name in a register kept by the issuer or its agent, and ownership transfers when the register is updated. Registered debt issues and shares traded in the secondary market are undivided: the whole issue is a single asset, and each unit is an identical, fungible part of it.

Bearer securities belong to whoever physically holds them. They transfer by delivery, sometimes with endorsement, and no register records the owner. Before electronic records, each bearer certificate was a separate, divided asset. Because anonymous ownership can facilitate tax evasion, regulators view these instruments unfavorably, and in the U.S. the Tax Equity and Fiscal Responsibility Act of 1982 effectively ended new bearer bond issuance.

Letter securities, also called restricted securities, letter stock or letter bonds, are sold directly by the issuer without SEC registration, so they cannot be sold freely to the public. The buyer signs an “investment letter” stating that the purchase is for investment and not for resale. Resale is possible only under specific conditions, most commonly the holding periods and other requirements of the SEC’s Rule 144.

Marketable vs. Non-Marketable Securities

A marketable security can be readily bought and sold in a public market. Shares of listed companies trade on stock exchanges. Treasury bills, notes and bonds trade in the bond market. Companies often hold marketable securities as a near-cash reserve on their balance sheets because they can be converted to cash quickly.

A non-marketable security cannot be freely sold to the public. Shares of private companies change hands only in limited circumstances, usually between qualified buyers and often with the company’s consent. U.S. savings bonds are registered to the owner and can be redeemed with the Treasury but cannot be sold to another investor. Non-marketable does not mean low value. It means turning the security into cash depends on the issuer or a narrow group of buyers.

Treasury Securities

Treasury securities are debt securities issued by the U.S. Department of the Treasury to finance the federal government. Backed by the full faith and credit of the U.S. government, they are treated as very low credit risk, are a standard holding for risk-averse investors and serve as a benchmark for other interest rates. The main marketable types differ by maturity and payment structure:

• Treasury bills mature in one year or less and are sold at a discount to face value instead of paying a coupon.
• Treasury notes mature in two to 10 years and pay interest every six months.
• Treasury bonds have the longest maturities (20 and 30 years) and also pay semiannual interest.
• Treasury Inflation-Protected Securities (TIPS) adjust their principal for inflation as measured by the Consumer Price Index.

Low credit risk is not the same as no risk. The market price of a long-term Treasury bond falls when interest rates rise, so an investor who sells before maturity can lose money.

Securities Regulation

In the United States, public offerings must be registered with the SEC unless an exemption applies, and registered issuers must file ongoing reports, such as annual and quarterly financial statements. State securities laws (“blue sky” laws) and state regulators apply alongside federal rules.

The SEC shares day-to-day oversight of brokers and dealers with self-regulatory organizations (SROs). The Financial Industry Regulatory Authority (FINRA) is the main SRO for U.S. broker-dealers, and exchanges act as SROs for their listed companies and members.

Regulation targets disclosure and conduct, not investment outcomes. Registration means an issuer has filed the required information, not that the SEC has approved the investment or judged it sound. Other countries have their own securities regulators and laws, and what counts as a security can differ across jurisdictions.

Securities vs. Stocks, Equities and “Financial Security”

Securities vs. stocks. A stock (a share) is one type of security: an equity security representing fractional ownership in a corporation, often with voting rights and a claim on dividends. “Securities” is the umbrella term that also covers bonds, notes, options, warrants, asset-backed securities and fund shares. When a regulator or court says an asset “is a security,” it means the asset falls under securities law. It does not mean the asset is a stock.

Securities vs. equities. Equities are ownership instruments, mainly common and preferred stock. All equities are securities, but debt securities and derivatives are not. On trading desks, equities usually means stock trading, while fixed income covers bonds and other debt securities.

Securities vs. “financial security.” In personal finance, financial security means a household has enough savings, income and insurance to handle expenses and shocks. It is unrelated to the legal or market meaning of a security, although owning securities is one way people try to build it.

Securities vs. indexes. A market index such as the S&P 500 measures the performance of a basket of securities but is not a security itself. Investors gain exposure to an index through securities that track it, such as index fund shares, exchange-traded funds or index options.

Limitations and Risks of Securities

• Market risk. Stock prices can fall sharply, and a bond’s market price drops when interest rates rise, even if the issuer pays every coupon.
• Credit and default risk. A debt security is only as reliable as its issuer and any collateral. Unsecured and subordinated holders recover less, or nothing, when an issuer fails, and common shareholders rank last.
• Liquidity risk. Restricted, privately placed and thinly traded securities, such as private company shares, can be hard to sell quickly or at a fair price.
• Dilution. Convertible securities, warrants and new share issuance reduce existing owners’ percentage stakes and per-share earnings.
• Complexity. Derivatives and structured products such as CDOs and tranched ABS can be difficult to value, and their risks may sit in features that are not obvious from the name.
• Leverage. Margin loans and many derivatives magnify losses, and losses can exceed the amount originally invested.
• Classification uncertainty. Whether a novel asset is a security may be decided only through enforcement or litigation, which affects which protections apply to buyers.

Disclosure rules reduce information gaps but do not prevent losses. An offering can be fully registered and accurately described and still perform badly.

The Bottom Line

Securities matter to anyone who buys stocks, bonds, funds or newer assets that may count as investment contracts under the Howey Test. The type of claim decides the risk: shareholders rank last in a bankruptcy, while secured creditors rank first. SEC registration requires disclosure but carries no approval, so a fully registered offering can still lose money through market, credit, liquidity or leverage risk.