By: Julio Perez, Fall 2017 Graduate Research Assistant
We may as well start with brass tacks: what is a security? Investor.gov defines a security as an “investment interest such as a stock or bond.” So I traded one word I did not understand for four. The NASDAQ website goes into a bit more detail, defining stock as “Paper certificates or electronic records evidencing ownership of equity (stocks) or debt obligations (bonds).”
So owning a security is literally having a piece of paper that lets the world know you either own a piece of a company or a company owes you money. But no explanation is complete without an example, so I present this scenario: Let’s say I am a big fan of fruit leather, so much so that not only do I want to show my support for the future of companies which produce fruit leather, but I also believe I can make a profit by doing so. So I walk up to a company representative for the hypothetically biggest fruit leather company of America, Dried, Rolled & Fruit, Inc. and offer to front some money for their operations and expenses if they promise me a cut of their profits. The representative then takes all five of the dollars I offered and says “This will get you one ‘share’ of our company, which means you own less than one-one-hundredth of our company.” This is “equity,” and I just bought a “stock”. If instead the representative says “thanks for the five dollars, I’ll pay them back later with interest,” then it would be called a “loan,” and I just bought a “bond.” The representative then hands me a rolled-up piece of paper that says exactly what she just said, along with some more investment jargon which I do not understand yet at this point of our blog series. “Great, my pocket change just turned me into a partial owner of a company, like I am a businessman or something!” I erroneously think to myself, but from a very technical point of view, I am correct!
This is because I just bought equity or loan capital, in the form of a written share certificate, which represents an investment interest in a stock or bond, which is also called a security! Of course, there are several other kinds of securities than the one I described in my hypothetical, and in the future I will identify them as they come up, but for now I learned that a security is the piece of paper I am holding representing my very tiny claim to a fruit leather company which will go up in value (be worth more money) if my company does well, or lose me five dollars if my company fails.
Translation: “I want to buy some sheets of paper that let the world know I own a piece of a company or a company owes me money, and hopefully I will make a profit when I turn this paper in at a later date.”