What are debt securities and equity securities? How…
Stocks and bonds are both securities. Learn about these investment securities and understand the difference between equity securities and debt securities.
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Key points to remember
- Equity securities are financial assets that represent shares of ownership
- Debt securities are financial assets that define the terms of a loan between an issuer and an investor
- Fixed income investments include securities such as corporate and government bonds, but also certificates of deposit, which are generally not securities.
Whether the bulk of your portfolio is in stocks or fixed income investments, most of us are familiar with the most common terms describing traditional investment securities: stocks, bonds, exchange-traded funds (ETFs) , mutual funds, etc. But sometimes specialized terms can leave the average investor confused or unsure.
For example, most investors are probably aware that stocks are also called actions. And an equity is a type of security. But not all investors may know the difference between a fixed income security and a stock. When it comes to bonds, most investors are probably familiar with the terms debt securities and fixed income securities. But maybe you’re not quite familiar with the specific characteristics that define and differentiate the two.
To add more confusion to the mix, the word Security may also vary in its legal definition from country to country.
So, in case you’re still wondering about the definition of securities in general versus stocks and bonds, let’s define some of the most common types of securities (according to US definitions).
What are securities in investing?
Securities are generally considered to be tradable financial assets. Although this is an oversimplification, “illiquid” securities that do not trade are not attractive or suitable for the vast majority of investors. Most securities are issued by institutions (usually corporations and governments) for the purpose of raising capital. Therefore, almost all securities are considered forms of investment.
Because investment securities cover a wide range of assets, they are divided into broad categories, two of which will be our primary focus:
- Equity securities (for example, common stock)
- Fixed income investments, including debt securities such as bonds, notes and money market instruments (some fixed income investments, such as certificates of deposit, may not be securities at all)
What are equity securities?
Equity securities are financial assets that represent shares of ownership. The most common type of equity security is the common stock. And the most defining characteristic of an equity security, what sets it apart from most other types of security, is ownership.
If you hold an equity security, your shares represent part of the ownership of the issuing company. In other words, you expect to profit from what could hopefully be an increase in the profits and assets of the issuing company. If you own 1% of the total shares, or security shares, issued by a company, your equity interest in the controlling company is 1%.
Other assets, such as mutual funds or ETFs, may be considered equity securities as long as their holdings consist of pooled equity securities.
What are debt securities?
Debt securities are financial assets that define the terms of a loan between an issuer (the borrower) and an investor (the lender). The terms of a debt security typically include the amount of principal to be repaid when the loan matures, interest rate payments, and the maturity date or renewal date.
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The most common types of debt securities are bonds, for example corporate bonds and government bonds, but also include other assets such as money market instruments such as commercial paper and notes.
When you buy a bond from an issuer, you are essentially lending the issuer money. Most of them case, you can lend money to receive interest payments on the money lent. (Some debt securities, such as exchange-traded notes, are used as substitutes for other negotiable instruments and offer no dividends or interest payments.) And at maturity, you expect to receive the full notional amount of your money.
Caution: Debt securities also involve risks, including price risk and credit risk, depending on the type of instrument and the issuer. Changes in interest rates can create price risk. Credit risk means the possibility that the borrower will not repay the debt when due.
What are fixed income investments?
Fixed income investments include debt securities that provide periodic, “fixed” interest payments to the investor. The most common types of fixed income investments are also securities, such as corporate bonds and government bonds.
Not all debt investments have a literally fixed payment. Some, in fact, have no payment at all, but instead build the effect of interest into the selling price up front. Other examples include certain variable income securities such as floating rate notes and floating rate demand bonds.
Other forms of debt securities include government treasury bills (T-bills) and treasury notes (T-notes).
Summary of titles
- Equity securities are financial assets that represent shares of a company.
- Debt securities are financial assets that define the terms of a loan between an issuer (borrower) and an investor (lender).
- Fixed income investments are investments geared towards interest income, including debt securities and certificates of deposit.