What are securities, and how do they originate?
Understanding Securities
In the world of finance, the term 'securities' frequently comes into play. But what precisely are securities, and how do they emerge? This comprehensive guide aims to take you on a journey through the realm of securities, providing a deeper understanding of their true essence and origination process.
Introduction to Securities
Securities are financial instruments that hold monetary value and represent an ownership position in an externally traded entity. This could be a publicly-traded company, a creditor relationship with a governmental body or corporation, or rights to ownership as represented by an option. These intangible assets are capable of being traded in financial markets and are used by entities to raise capital they need.
Types of Securities
Securities are mainly composed of two types- equity securities and debt securities.
Equity Securities
Equity securities represent ownership interest held by shareholders in an entity (a company, partnership or trust), realized in the form of capital stock. The holder of equity securities is essentially a part-owner of the company and stands to gain significantly should the company perform well.
Debt Securities
On the contrary, debt securities such as bonds, notes, or debentures are essentially loans, often secured by specific assets. The issuer of debt securities is essentially borrowing funds and offering the lender a return on their investment via regular interest payments and the return of principal once the securities mature. Debt securities are typically less risky than equity securities but offer lower potential returns.
Origination of Securities
The process by which securities come into being is called Origination. This involves the creation of a security and its subsequent sale to investors. Let's break this process down.
Step 1: Decision to Raise Capital
The origination process of securities begins when a company, government, or other entity decides to raise capital. This decision is usually contingent on the entity's need for funds to finance growth or operational expenses, or to pay off existing debts.
Step 2: Underwriting Process
The process of securities origination typically involves an underwriting firm. This financial intermediary assists in the process of issuing new securities. Underwriting firms help ascertain the initial offer price of the securities and buy them from the issuer, then sell these securities to investors. The risk of not being able to sell the securities at the stipulated price rests with the underwriter.
Step 3: Legal Documentation
A further step in the origination process involves the generation of legal documents that detail the terms and conditions of the securities being offered. These documents outline the rights of investors and the obligations of the issuer. They are then submitted to the relevant securities regulatory body (like the Securities and Exchange Commission in the US).
Step 4: Sale to Investors
Once the securities have been created and approved, they are ready for sale. They are furnished on a securities exchange market, where investors can purchase them. The company, government, or entity that issued the securities initially then receives the proceeds from this sale.
In Conclusion
Understanding the concept of securities is crucial for both investors looking to diversify their portfolios and companies aiming to raise funds. These financial instruments, ranging from equities to debentures, offer a myriad of opportunities for every player in the financial field. Their origination process, while multi-layered, serves as a remarkably well-organized system to ensure transparency, legality, and fairness in the issuance of new securities. Also, it's crucial to remember that while securities offer substantial income potential, they likewise accompany their set of risks, making it essential for investors to conduct thorough research and due diligence before investing.
