1.1 Securities | BATwebsite

The basics of securities: Equities and debts

As covered before, securities are financial instruments with negotiable prices and can be traded with other goods. (The property of which is called Fungibility). Since this definition is vague, economists have used two sub-categories to group securities: Equities and Debts.

Equities are, simply put, ownerships in assets. Holding a equity means having a stake in assets. A common type of equity is stocks.

Debts, however, are securities that represent money that is borrowed and must be repaid. Note that you need not be the borrower;in fact, you may be a debtor.

In this section, we will cover the most popular types of securities: Stocks, Bonds, ETFs, Options, and CDs

01

Stocks

Stocks are the most common type of securities traded in the world. Stocks are, essentially, ownership in a certain company. When you buy stocks, you are buying a part of a company. Companies that issue stocks are called "Public companies" and are publicly listed on the stock exchange.

Well then, why buy stocks?

There are two reasons why people buy stocks. The main reason being that the stock might rise in value. If a company reports strong sales for the year, the total value of the company will increase, thus increasing the value of a stock. It is then possible to sell the stocks for a profit.

Additionally, people might also buy stocks to receive dividends. Dividends are returns on your investment of the stock. Since you own a part of the company, you are entitled to a part of their earnings. Hence the earnings you receive are called Dividends.

There are two types of stocks: Common and Preferred. Common stocks are, well, the most common. They allow holders to receive dividends and attend and vote during the company's Annual general meeting (AGM).The ability to vote during AGMs on company matters are called Voting Rights.

Preferred stocks do not have voting rights but receive priority on dividends and a larger claim on company assets.

The purpose of stocks is to raise money for a company to expand. If a company is private, it has limited avenues to raise money to expand. However, when a company goes public, it has the ability to raise money via the issuance of stock. When you buy a stock, the company uses the money to invest in it's business. In return, you get the returns of the investments the company makes. A company expands to make use of economies of scale, which are benefits that a large company enjoy, such as lower costs when it buys supplies in bulk etc.

Whenever companies decides to go public, it organizes a Initial public Offering (IPO). In short, it is the launch of new stock in the stock exchange. Pictured below is the IPO of Alibaba, one of the largest IPOs in modern times.

02

ETFs

ETFs stands for "Exchange Traded Fund" and is categorized under a special type of securities called "Derivatives".

Derivatives are a special type of securities whose value derives from the value(or change) of other securities. They do not have inherent values as its value comes from the value of other assets.

In this case ETFs are funds that invest in a group of stocks or other assets. Hence, it's value derives from the value of the stocks which are bought in the funds. In most cases, ETFs track a basket of stocks in which it invests in. The value of the ETF mirrors that of the stocks within the fund.

To put in simply, imagine ETFs as a pool of money. Let's say there are a total of 10 stocks in the world, but you don't have the money to buy all of them. So, you and your friends decide to pool money together and buy all 10 stocks. The money pooled together is called an ETF.

In reality, ETFs track thousand of stocks and other securities and is an important tool of risk management as your investment is diversified. This will be covered in the tips section of this website.

A popular ETF would be the SPY ETF, which aims to follow the famous S&P 500 index and it's returns.

In this example, the SPY ETF contains stocks of companies within the S&P 500 index and allows investors to buy into the pool of stocks. Shown below is the graph of the SPY ETF:

03

Bonds

Bonds are categorized under Debt securities as it is, essentially, a loan.

A bond is a financial document in which the issuer of the bond (typically a government) promises to pay interest on the bond until it matures, in which the bond is "Redeemed" at the price at which you bought the bond at ("Face value").

In short, a bond is a glorified IOU in which you are the lender and the issuer of the bond is the borrower. The interest paid on the bond is called the Yield of the bond, the amount you bought the bond at is called the Principal Amount or Face value, and when the issuer pays back the principal amount the bond is said to have Matured. Bonds have varied lifespans, from 1 Year to 10+ Years. Typically, the longer the bond, the better the returns.

Bonds are called "Fixed income" investments as they provide a steady flow of income from the interest paid. They are among the safest investments in the financial world and are great if you are risk adverse.

The most important aspect of the bond is the yield. Yields are important as they represent your returns and the risk in buying the bond. Risker Bonds have higher returns and vice versa. Most famously, one of the safest bonds in the world, the Swiss bond, once had a Negative return (meaning you were paying to lend money!) due to it's security.

In Singapore, a popular bond issued by the government is the Singapore Saver's Bond (SSB). From the picture below, one can easily see why it is popular. Not only does the interest rates beat inflation, it is a low risk, invest-and-forget investment that appeals to people who don't want to fuss around with the stock market.

Interest calculator courtesy of the Singaporean Government: Link

Interest rates of the SSB:

04

Options

Options are are a derivative security (remember ETFs?) that derive it's value from the changes in Stocks price and it's potential value in the future.

But what exactly are options? Simply, options are derivative securities that give you the option to buy and sell stocks at a certain price. When you buy an option, you buy the right to buy or sell a stock at a certain price. In short, you're betting on whether a stock goes up, or down.

There are two types of options: Calls and Puts. Calls are the right to buy a stock at a certain price, whereas Puts are the right to Sell stocks at a certain price.

To illustrate, lets say the stock of company A is $100. You think the the stock is going to go up, so you buy a call option @$10 for the right to buy the stock at $100. This means that if the stock goes beyond $110 (100+10), you make a profit. The price at which you make neither a loss or profit is called the Break-even point.

In the diagram below, it illustrates the profit/loss of options. -100 Represents the amount invested into the option and any positive value on the Y axis represents profit. 0 represents break-even.

Then, why trade options when it is much easier to just buy stocks?

Well, Options give investors the ability to control stocks with relatively little money. Traditionally, if one wants to invest in a stock, he has to buy all of the stocks with his money. Options give flexibility as it allows investors to buy the right to buy stocks, instead of outright buying the stocks instead.

Furthermore, since options cost less than the actual stock, potential losses are lower. If one has to buy a stock for $100 or a option for $10, the potential loss on the option is limited to the amount invested, being $10 instead of $100.

05

CDs

CDs stand for "Certificate of deposit" and is another type of Debt security. However, unlike bonds, CDs are normally issued by banks instead.

A CD acts like a bond in many ways as it pays out Interest and has a maturity date. However, CDs are one of the most restrictive investments on the Planet as it restricts investors from access to the initial investment. In many examples, if an investor decides to withdraw the investment, the investor will occur a Withdrawal penalty. In many cases, all the interest earned will be forfeited.

Additionally, unlike bonds, CDs tend to be bigger investments. It is not uncommon for CDs to cost upwards of 100k. Many banks also require a minimum bank balance for a CD to be brought. CDs that cost upwards of 100k are called Jumbo CDs, while smaller CDs are called small CDs.

Most CDs have fixed interest rates and most yields tend to be better than you would find elsewhere within a bank.

However, CDs are not traded on the financial exchanges and are usually used for long term saving, such as retirement saving.