Welcome to Money Basics, Yahoo Finance’s new personal finance series offering quick explanations for some of the most important terms involving your money.
If you’ve ever read anything about Wall Street, chances are you’ve seen the term “security” or “securities.”
A security is a financial instrument that holds some value, such as a stock, bond or option. Securities fall into one of three categories: equity, debt and derivative. Equity securities such as stocks represent ownership in a company, while debt securities like bonds must be repaid.
The third category of securities, derivative securities, have value derived from an underlying security. Options fall into this category. Options represent a contract that gives you the right — but not the obligation — to buy or sell a security at a set price. Call options let you buy at that agreed-upon price, while put options let you sell at that price. (Complex derivative securities known as collateralized mortgage obligations played a role in the 2008 financial crisis.)
Stocks are typically better understood than derivative securities. They represent ownership in a publicly traded company like Coca-Cola or McDonalds and a claim on those companies’ assets and earnings. A company’s stock price can go up or down, depending on a variety of factors (a PR scandal could hurt a company’s stock, for example. Or a company’s stock could benefit from a booming economy.)
If you buy a stock and it goes down before you sell it, then you lose money. But you stand to gain money if the stock price goes up before you sell.
Bonds, meanwhile, let you loan money to a company or government entity, which will pay it back with interest. The allure of bonds for companies or governments is that they can have lower interest rates than bank loans. Many cities rely on municipal bonds to raise money for special projects like the construction of schools or roads. Companies also rely on bonds for general expenses and special projects.
The Securities and Exchange Commission oversees and enforces securities regulations in the United States. The SEC was created with the Securities Exchange Act of 1934 with the original mission of restoring investor confidence in the financial markets following the stock market crash of 1929.