What are equity securities?
What is the difference between equity and debt securities?
What type of equity security can investors purchase?
We will look at the equity security definition, look at the different types of equity securities, see how you can invest in them, how they are classified, look at the accounting for equity securities, debt securities vs equity securities, examples and more.
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Table of Contents
What are equity securities
To understand what is an equity security, let’s quickly define what is a “security”.
The term security represents a financial instrument having some monetary value.
They are negotiable and fungible.
Securities can be in the form of “equity securities” or “debt securities”.
In this article, we will focus on the securities by way of equity.
Now, “equity securities” represent ownership interests in a legal entity such as a corporation, company, partnership, trust or other business entity by way of shares.
There are typically two types of equity securities companies issue from their capital stock: common shares and preferred shares.
To better understand what are equity securities, think of shares that you may buy in a publicly-traded company on the stock market.
For example:
If you buy shares of Coca-Cola on the stock market, you are essentially buying equity securities or ownership interest in Coca-Cola.
The stock market is essentially an equity securities market where you buy and sell equity in listed organizations.
The holders of equity securities may have any of the following rights in the business entity:
- Right to vote (ability to have an influence or control the company)
- Right to receive dividends (ability to receive profits distributions)
- Right to receive proceeds of liquidation (ability to receive residual value of the company once all company debt and liability is paid off)
Some equity securities will grant the security holder all the three rights mentioned above and some may carve out some of these rights.
Common shares offer typically offer the following rights to the shareholders: (1) the right to vote in the company affairs and elect the board of director, (2) the right to receive dividends if the board declares dividends and (3) the right to receive residual value proceeds once all the creditors of the company and company debt have been paid off in the event of liquidation or bankruptcy.
Equity securities definition
According to Investopedia, equity securities are defined as:
An equity security represents ownership interest held by shareholders in an entity (a company, partnership, or trust), realized in the form of shares of capital stock, which includes shares of both common and preferred stock.
What is notable with this definition of equity securities is that equity securities provide ownership interest in a business entity.
Types of equity securities
There are different types of equity securities granting the equity security holder ownership rights in the company.
The most common type of equity securities are:
- Common stock
- Preferred stock
You also have hybrid types of equity securities such as:
- Convertible bonds (callable bonds)
- Convertible stocks
- Warrants or equity warrants
- Stock options
You can have equity securities classified by categories such as:
- By company industry (banking, consumer discretionary, insurance, energy)
- By degree of liquidity (private or public)
- By company market capitalization (Over billion in market cap)
- By markets (NYSE)
- By country (American stock)
- By income payments (dividend stock)
- By tax treatment (taxable or tax-free)
- By company income (over billion in net income)
Equity securities can also be categorized by investor type as well:
- Private investors
- Institutional investors
- Retail investor
- Wholesale investor
- Qualified investor
Investment in equity securities
Companies and business entities who sell equity securities are called “issuers” and those who buy the equity securities are called “investors” or “equity investors”.
Issuers are typically publicly-traded companies, multinationals, international companies, partnerships or other commercial enterprises selling ownership rights.
There are different ways you can invest in equity securities.
The most common type of investment in equity securities is to buy and sell publicly traded stock on the stock market or stock exchange.
You can purchase equity securities through a stockbroker or “over-the-counter” where investors directly place electronic buy and sell orders online or by phone.
The stock market offers a generally safe and regulated environment where companies can attract investors and investors can find companies matching their risk tolerance.
Some investors purchase equity securities that regularly pay dividends (blue-chip stocks), some investors like to bet on promising new ventures (penny stocks) and others take a more balanced investment approach.
For a company to publicly sell its equity securities, it must get listed on the stock exchange through a process called the initial public offering or IPO.
When the company stocks are sold for the first time by the company to the public, we refer to that as the issuance of equity securities for sale in the primary market.
Then, once investors purchase the stock of a company and start trading them between themselves, we refer to that as the secondary market.
A company can also sell equity securities through a process called private placement.
A private placement is when a company sells its equity securities to professional or qualified investors privately.
Companies do sell their securities in this fashion to remain in compliance with securities laws and ensure they comply with the Securities and Exchange Commission rules or other similar governing bodies.
Equity security accounting
From an accounting point of view, equity security represents an “investment in stock” in a corporation, partnership or business entity.
There may be a different accounting treatment depending on how much an investor acquires control over a company through its equity investment.
Here are the three possible accounting for equity securities:
- Cost method
- Equity method
- Consolidated financial statement
The cost method is used when the investor or equity investment grants the investor less than 20% of the voting rights or control over the company.
The equity method is used to account for the equity investment when the investor purchases an equity stake over 20% but below 50% ownership in the company and does not have control of the company’s board of directors.
Having between 20% to 50% of the company stocks or equity shares, the investor will have the ability to influence the company’s decisions in an important way.
Finally, a consolidated financial statement should be prepared when the investor purchases more than 50% of the company stocks where the investor is deemed to have control over the company.
Securities vs equities
What is the difference between the term “securities” and “equities”?
The term “security” broadly refers to a financial instrument whereas the term “equities” refers to a type of securities.
Let me explain.
A security investment can be:
- Debt securities
- Equity securities
- Derivative instruments
Typically, a security investment is a tradable financial asset (some are liquid and some are illiquid).
With a security investment, you can either own percentage ownership of a company by purchasing equity securities or become a creditor of the company by purchasing debt securities.
Some example of securities, in general, can be:
- Common stocks
- Fixed income securities
- Corporate bonds
- Government bonds
- Treasury bills
- Treasury notes
- Corporate debentures
- Government debentures
- Notes
- Commercial paper
- Money market instruments
- Exchange-traded notes (ETN)
- Secured debt
- Unsecured debt
- Senior subordinated debt
- Junior subordinated debt
Some examples of derivatives can be:
- Forwards
- Futures
- Options
- Swaps
You can own securities or investments in corporations, governments, municipalities or other business entities or governmental bodies.
On the other hand, equity securities represent an investment where the investor becomes a part “owner” in proportion to the equity stocks purchased or on a pro-rata basis.
Enquiry securities are shares in a company or corporation.
For example:
If you purchase 5% of a company’s total outstanding issued shares, you can say that you are the owner of 5% of the company.
You have a 5% controlling interest in the company as a minority shareholder.
If you own more than 50% of the shares of a company, you are a majority shareholder and have a controlling interest in the company.
An equity investment can be:
- Common stocks
- Preferred stocks
- Convertible shares
- Mutual funds (if all the mutual fund investment is in equity stocks)
- Exchange-traded funds or ETF (if all the ETF investment is in equity stocks)
- Depositary receipts (global depositary receipts)
Debt vs equity securities
What is the difference between equity securities vs debt securities?
Debt securities represent a financial asset where the investor (creditor or lender) is entitled to have his or her investment capital paid back along with interest over a certain period of time by the issuer (borrower).
For example:
Microsoft issues corporate debentures promising the investors to pay back the sums borrowed in 3 years along with 8% interest.
If an investor purchases $10,000 of Microsoft debentures, the expectation is that Microsoft as the issuer will have to reimburse $10,800 in capital and interest to the investor or lender.
With debt securities, the investor is guaranteed a specific percentage interest or return on the investment.
Consider debt securities to be a loan made by a lender to a borrower.
The lender expects to get his or her money paid back along with interest representing the profit to the lender.
Equity securities represent shares or stocks that an investor purchases in a company.
An investor buying stocks becomes a part-owner of the company.
As a part-owner, the investor hopes to make money through the appreciation of the value of the company (capital gains).
The company issuing shares gives up a percentage of equity or ownership in exchange for the investor’s money.
As a result, the company does not have an obligation to pay back the investor the invested money with interest.
Some equity shares entitled the equity investor to dividends (preferred shares) and some do not although dividends can be paid by the company (common shares).
Equity security examples
Let’s look at some equity security examples to show how an investor may acquire an ownership claim in a company.
Here are some examples:
- Common shares
- Callable common shares
- Putable common shares
- Preference shares
- Cumulative preference shares
- Participating preference shares
- Callable and putable preference shares
- Depository receipts
- American depository receipts
Equity securities FAQ
What is an equity security
An equity security is a financial instrument that may have the following characteristics:
What are examples of equity securities
The most common example of equity securities available is common stocks.
You also have other examples, although less common, such as preferred stocks.
Some equity securities can be classified as “hybrid” such as convertible bonds, convertible notes, warrants, stock options, call options, put options or other types of derivatives.
What are the two major types of equity securities
The two major types of equity securities are common shares and preferred shares.
Common shares provide the investor with a percentage of ownership in a company along with voting rights.
The more a person or company has common stocks in a company, the more that shareholder can have an influence over the company’s board of directors or even control the company.
Preferred shares typically do not grant the investor voting rights in a company although they are reflected in a company’s share capital.
What is the difference between debt securities and equity securities
Debt securities are like loans where the investor lends money to the issuer who borrows that money for a certain period of time.
The debt security investor expects to make a profit by having the borrower reimburse the capital along with interest.
The higher the interest, the more the debt security holder will earn in profits.
Equity securities are similar to the title to a property.
In the case of equity securities, the investor has title to stocks of a company represented by a share certificate in some cases non-certificated shares (book-entry interest or depositories).
The equity security investors invest in a company to become a part-owner.
As a part-owner, the investor does not expect his or her investment to be reimbursed but hopes that the company will become more and more profitable so that it can potentially receive dividends and have the fair market value of the shares appreciate over time resulting in capital gains.
Is an ETF an equity security
ETF or Exchange Traded Fund represents a pool of securities that can include security in the form of equity or debt such as common stock, preferred stock, foreign equities, closed-end funds, bonds, options or other securities bought and sold in real-time on a stock exchange.
On the other hand, you can define equity securities as ownership stakes in corporations.
While an ETF is not limited to only equity securities, equity securities are things like common stock and preferred stock.
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