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101 Concepts for the Level I Exam

Concept 68: Types of Securities

Securities can be broadly classified into:
Fixed income: refers to debt securities where the borrower is obligated to pay interest and principal at pre-determined schedule. They may be collateralized, which means that investors have claim on certain physical assets. The different types are:
• Bonds: Long-term debts.
• Notes: Intermediate-term debts.
• Bank borrowings: Long to short term involving revolving credit lines and other debt instruments.
• Convertible: Debt can be exchanged for a specified number of equity shares.
Equity: refers to ownership claims by investors in companies. The different types are:
• Common shareholders: have a residual claim over any assets and income, after all the senior securities have been paid.
• Preferred shareholders: are paid scheduled dividends before the common shareholders.
• Warrants: give the holder a right to buy the firm’s security at a price called the exercise price, within a specified time period (similar to options).
Pooled investments: refer to structures that combine investment from many investors. The different types are:
• Mutual funds: can either be open-end (shares purchased from fund) or close-end (shares purchased from other investors) funds.
• Asset backed securities: represent claim on cash flow earned by the assets in the portfolio like mortgages, car or credit card debt.
• Exchange traded funds (ETFs): combine the advantages of open-end and closed-end funds.
• Hedge funds: utilize different strategies and often rely on leverage.
Contract is an agreement between traders to perform some action in the future which can either be settled physically or in cash. The types of contracts (also termed as derivatives) are:
Forward contract is an agreement to trade the underlying asset at a future date at a pre-specified price. It is not standardized and not traded on public exchanges.
Futures contract is a standardized contract where the amount, asset characteristics and delivery date are the same for all contracts. It is exchange trade and has higher liquidity because of standardization.
Swap contract is an agreement to swap payments of one asset for the other. The different types are:
• Interest rate swap: Floating rate payments are swapped for fixed-rate payments for a specified period.
• Currency swap: Currency amount swapped for another currency for a specified period.
• Equity swap: Returns earned on one investment are swapped for the other.
Options are contracts that give the holder a right, but not the obligation, to buy/sell an underlying security at a specified price, at or before a specific date. The different types are:
• Call option: Buyer gets the right but not the obligation to buy the underlying security at a predetermined price; seller of the call option gets the premium but has to the sell the security if the buyer exercises his option to buy.
• Put option: Buyer gets the right but not the obligation to sell the underlying security at a predetermined price; seller of the put option gets the premium but has to the buy the security if the buyer exercises his option to sell.
Credit default swaps offer insurance and make payment to the insurance holder if a borrower defaults on its bonds.
Currencies, are legal tenders issued by national monetary authorities, that trade in the spot, forward, or futures markets (also called as the Forex market).
Commodities include energy products, precious metals, industrial metals, agricultural products, and carbon credits. They trade in spot, forward and futures markets.
Real assets are physical assets which are normally used by operating companies as factors of production. (For e.g. real estate, plant and equipment etc.)

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