Marketable securities are a type of financial instrument that investors can easily convert to cash. They are quite diversified, encompassing products such as ordinary stocks and treasury bills. If you’re thinking about or starting a career in finance, understanding marketable securities will help you build the necessary abilities for working with these liquid financial assets.
Marketable securities are tradable financial assets with high liquidity, allowing investors to easily convert them into cash. Investors can buy and sell marketable assets on stock exchanges, which typically mature in less than a year. These securities are in high demand because the corporations who invest in them can use them as a store of value. They can sell or convert them into cash rapidly, with minimal price swings.
Marketable securities are distinct from other financial instruments because of their high marketability. Like other securities, financial institutions and companies can create, modify or settle them. Key characteristics of marketable securities include the following:
- ready availability for purchase or sale on a public exchange
- high saleability
- strong secondary marketability
- low risk and low return (no large fluctuations in value)
- easily transferable between parties with timely transactions
- simple conversions into cash (high liquidity) in a year or less
Types of Marketable Securities
There are numerous types of marketable securities, but stocks are the most common type of equity. Bonds and bills are the most common debt securities.
Stocks As Securities
Stock represents an equity investment because shareholders maintain partial ownership in the company in which they have invested. The company can use shareholder investment as equity capital to fund the company’s operations and expansion.
In return, the shareholder receives voting rights and periodic dividends based on the company’s profitability. The value of a company’s stock can fluctuate wildly depending on the industry and the individual business in question, so investing in the stock market can be a risky move. However, many people make a very good living investing in equities.
Bonds As Securities
Bonds are the most common form of marketable debt security and are a useful source of capital to businesses that are looking to grow. A bond is a security issued by a company or government that allows it to borrow money from investors. Much like a bank loan, a bond guarantees a fixed rate of return, called the coupon rate, in exchange for the use of the invested funds.
The face value of the bond is its par value. Each issued bond has a specified par value, coupon rate, and maturity date. The maturity date is when the issuing entity must repay the full par value of the bond.
Because bonds are traded on the open market, they can be purchased for less than par. These bonds trade at a discount. Depending on current market conditions, bonds may also sell for more than par. When this happens, bonds are trading at a premium. Coupon payments are based on the par value of the bond rather than its market value or purchase price. So, an investor who purchases a bond at a discount still enjoys the same interest payments as an investor who buys the security at par value.
Interest payments on discounted bonds represent a higher return on investment than the stated coupon rate. Conversely, the return on investment for bonds purchased at a premium is lower than the coupon rate.
Preferred Shares
There is another type of marketable security that has some of the qualities of both equity and debt. Preferred shares have the benefit of fixed dividends that are paid before the dividends to common stockholders, which makes them more like bonds. However, bondholders remain senior to preferred shareholders. In the event of financial difficulties, bonds may continue to receive interest payments while preferred share dividends remain unpaid.
Unlike a bond, the shareholder’s initial investment is never repaid, making it a hybrid security. In addition to the fixed dividend, preferred shareholders are granted a higher claim on funds than their common counterparts if the company goes bankrupt.
In exchange, preferred shareholders give up the voting rights that ordinary shareholders enjoy. The guaranteed dividend and insolvency safety net make preferred shares an enticing investment for some people. Preferred shares are particularly appealing to those who find common stocks too risky but don’t want to wait around for bonds to mature.
Exchange-Traded Funds (ETFs)
An exchange-traded fund (ETF) allows investors to buy and sell collections of other assets, including stocks, bonds, and commodities. ETFs are marketable securities by definition because they are traded on public exchanges. The assets held by exchange-traded funds may themselves be marketable securities, such as stocks in the Dow Jones. However, ETFs may also hold assets that are not marketable securities, such as gold and other precious metals.
Other Marketable Securities
Marketable securities can also come in the form of money market instruments, derivatives, and indirect investments. Each of these types contains several different specific securities.
The most reliable liquid securities fall in the money market category. Most money market securities act as short-term bonds and are purchased in vast quantities by large financial entities. These include Treasury bills, banker’s acceptances, purchase agreements, and commercial paper.
Many types of derivatives can be considered marketable, such as futures, options, and stock rights and warrants. Derivatives are investments directly dependent on the value of other securities. In the last quarter of the 20th century, derivatives trading began growing exponentially.
Indirect investments include hedge funds and unit trusts. These instruments represent ownership in investment companies. Most market participants have little or no exposure to these types of instruments, but they are common among accredited or institutional investors.
The overriding characteristic of marketable securities is their liquidity. Liquidity is the ability to convert assets into cash and use them as an intermediary in other economic activities. The security is further made liquid by its relative supply and demand in the market. The volume of transactions also plays a vital part in liquidity. Because marketable securities can be sold quickly with price quotes available instantly, they typically have a lower rate of return than less liquid assets. However, they are usually perceived as lower risk as well.
Read Also: Cash is King: Why Cash is Considered the Ultimate Liquid Asset
From a liquidity standpoint, investments are marketable when they can be bought and sold quickly. If an investor or a business needs some cash in a pinch, it is much easier to enter the market and liquidate marketable securities. For example, common stock is much easier to sell than a nonnegotiable certificate of deposit (CD).
This introduces the element of intent as a characteristic of “marketability.” And in fact, many financial experts and accounting courses claim intent as a differentiating feature between marketable securities and other investment securities. Under this classification, marketable securities must satisfy two conditions.
The first is ready convertibility into cash. The second condition is that those who purchase marketable securities must intend to convert them when in need of cash. In other words, a note purchased with short-term goals in mind is much more marketable than an identical note bought with long-term goals in mind.
Examples of Marketable Securities
Equity securities
Equity securities are a broad class of ownership assets rather than debt. Investors don’t hold equity securities as long-term investments but keep them available for sale. Banks commonly trade these equity instruments on the stock exchange.
Debt securities
This large class of financial instruments rely on debts rather than assets. Debt securities contain a promise to pay the bearer the balance in a specific timeframe. The trades of these occur on bond markets and include government bonds and commercial papers.
Stocks
Stocks, or equity, is a type of marketable security that denotes ownership of a certain percentage of the corporation that issues them. Each unit of stock is a share, and stock owners can trade them on a stock exchange. Below is an explanation of the two types of stocks:
- Common stocks offer corporate equity ownership with rights to a corresponding proportion of company profits and voting rights on corporate policy and the board’s composition.
- Preferred stocks entitle the owner to prioritised, fixed dividends and a stronger claim to the assets if the issuing corporation is liquidated.
Bonds
Bonds are debt security that corporations and governments issue as tradable assets. These are fixed-income instruments that pay a set interest rate to the owner of the debt. They carry a maturity date by which the bond issuer pays the outstanding amount.
Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) comprise multiple securities available as a basket on the stock exchange. The marketable securities they include can be stocks and bonds from domestic or international corporations. These pooled securities fluctuate in price throughout a day of trading and offer a low expense ratio.
Treasury bills (T Bills)
Treasury bills, or T bills, are debt securities, or unconditional obligations, that governments issue to raise investment quickly. They’re short-term instruments that the treasury of the issuing country backs. T bills are generally low risk as they mature in a year and are available in low denominations.
Bills of exchange
These are secured debts and short-term financial instruments. Companies that issue bills of exchange typically use them to acquire inventory or deal with short-term liabilities. The bill of exchange specifies the owner of the debt, the sum of money the parties exchange and the due date for payment.
Certificates of deposits
Financial institutions issue this type of marketable security in place of depositing funds in the bank for a specific period. They’re transferable and have maturity periods ranging from a few days to one year. It’s difficult to lose money on them, as a bank or other financial institution backs them.
Commercial papers
These short-term debt instruments are unsecured and mature within 270 days. Corporations and businesses use them for short-term financing, but they carry the risk of non-payment. The financial authorities do not regulate commercial papers, meaning that issuers provide them at a percentage of their face value.
Stock rights and warrants
Stock rights and warrants permit an existing shareholder to purchase additional stock for a discount while maintaining the overall level of ownership. Corporations that want to raise additional capital quickly use them. If companies issue too many stock rights, they can lower the value of each share.
Futures
Futures, or futures contracts, are agreements on purchasing a particular asset for a set amount on a future date. Businesses often use futures to hedge risks and financiers trade and speculate on them. Because futures contracts often trade with excessive leverage, they’re a high-risk investment.
Options
Options allow holders to buy or sell an asset or financial instrument at a specific price in a set period. They’re highly flexible financial instruments that widely vary according to contract structure. Options can be highly speculative and risk remaining unsold before they expire.
Evaluating Risk and Return of Cash Equivalents and Marketable Securities
1. Understanding the Risk and return of Cash Equivalents and Marketable Securities
When it comes to managing liquidity, cash equivalents and marketable securities play a crucial role in maximizing financial resources. However, it is essential to evaluate the risk and return associated with these investment options to make informed decisions. In this section, we will delve into the factors that should be considered while evaluating the risk and return of cash equivalents and marketable securities.
2. Risk Assessment: Cash Equivalents vs. Marketable Securities
Cash equivalents, such as money market funds and Treasury bills, are considered to have lower risk compared to marketable securities. This is because cash equivalents are highly liquid and typically have a fixed maturity date, ensuring the principal amount is preserved. On the other hand, marketable securities, such as stocks and bonds, carry a higher level of risk due to market fluctuations and the potential for loss of principal.
To assess the risk associated with cash equivalents and marketable securities, it is crucial to consider factors such as credit risk, interest rate risk, and market volatility. For example, credit risk refers to the possibility of default by the issuer of a marketable security, whereas interest rate risk pertains to the impact of fluctuations in interest rates on the value of fixed-income securities.
3. Return Evaluation: Yield and Potential for Capital Appreciation
While cash equivalents offer stability and preservation of capital, their return potential is relatively low. These investments typically generate income in the form of interest, and the yield is influenced by prevailing interest rates. On the other hand, marketable securities have the potential for both income generation and capital appreciation.
When evaluating the return of marketable securities, investors should consider the dividend yield for stocks and the coupon rate for bonds. Additionally, the potential for capital appreciation should be assessed by analyzing historical performance and market trends. It is important to note that higher returns often come with increased risk, and a balanced approach is necessary to maximize both liquidity and returns.
4. Tips for Evaluating Risk and Return
– Diversify your investments: Spreading your investments across various cash equivalents and marketable securities can help mitigate risk. This diversification strategy ensures that a potential loss in one investment is offset by gains in others.
– Stay informed: Keep up-to-date with market news and economic indicators to assess the risk and return potential of different investment options. This information can help you make informed decisions based on current market conditions.
– Consult with financial professionals: Seeking advice from financial advisors or experts can provide valuable insights into evaluating risk and return. They can help analyze your financial goals and risk tolerance to recommend suitable cash equivalents and marketable securities.
5. Case Study: Evaluating risk and Return in a portfolio
Consider a scenario where an investor has a significant amount of cash that needs to be invested for liquidity purposes. The investor evaluates various options, including money market funds, Treasury bills, and a mix of stocks and bonds.
After assessing the risk and return of each investment option, the investor decides to allocate a portion of the cash to money market funds and Treasury bills for stability and liquidity. Simultaneously, a portion is invested in a diversified portfolio of stocks and bonds to achieve higher returns and potential capital appreciation.
By carefully evaluating the risk and return of different investment options, the investor ensures a balance between liquidity and maximizing returns.
Evaluating the risk and return of cash equivalents and marketable securities is crucial for maximizing liquidity. By assessing factors such as risk, return, and diversification, investors can make informed decisions to achieve their financial goals. Remember to stay informed, diversify your investments, and seek professional advice when evaluating the risk and return of these investment options.
Advantages and Disadvantages of Marketable Securities
Pros of Marketable Securities
Marketable securities can be quickly and easily converted into cash, making them a highly liquid investment. This can be especially important for investors who need access to their funds in the short term but don’t want to lose purchasing power by simply holding onto cash.
By investing in a variety of marketable securities, investors can achieve a diversified portfolio that spreads risk across multiple assets. This can help to reduce specific investment risks in addition to offering the potential for attractive returns.
Many types of marketable securities are readily accessible to individual investors including stocks, bonds, mutual funds, and ETFs. This makes it easy for investors to buy any of the securities mentioned above, as there are usually minimal limitations outside of a simple brokerage account needed to get started.
Cons of Marketable Securities
While marketable securities offer a range of benefits, there are also some downsides to consider. All marketable securities are subject to market risk, meaning that their value can fluctuate based on market conditions. This can lead to losses for investors, even those who hold “safer” marketable securities even for a short period of time.
Buying and selling marketable securities typically involves transaction costs such as brokerage fees and commissions. These costs can add up over time, reducing the overall returns earned by investors. Some types of marketable securities such as bonds already offer more stable returns but with limited upside potential, so investors may struggle to turn a profit on highly-exchanged securities.
Some types of marketable securities can be highly volatile. This volatility can be emotionally difficult for some investors to tolerate, and it may also make it difficult for investors to achieve long-term investment goals.
Finally
There exist liquid assets that are not marketable securities, as well as marketable securities that are not liquid assets. For example, a newly minted American Eagle Gold Coin is a liquid asset but not a marketable security. However, a hedge fund may be a marketable investment but not a liquid asset.
Every marketable security must nevertheless meet the criteria for being a financial security. It must represent an owner’s or creditor’s interest, have an assigned monetary value, and provide the purchaser with a profit potential.