The Main Financial Securities: Stocks, Bonds, and Derivatives
Stocks, bonds, and derivatives — understand the three main families of financial securities and their key differences for the CSI's IFC exam.
The Main Financial Securities: Stocks, Bonds, and Derivatives
Understanding the Basics of Investing
When you start looking into investing, a handful of terms come up quickly: stocks, bonds, Treasury bills, options, mutual funds, ETFs...
To a beginner, all these products can seem like they belong to the same category. They don't.
Before you can understand mutual funds or ETFs, it's essential to know the financial securities that make up those products. In this article, we'll look at the three main families of financial securities:
Equity securities
Debt securities
Derivative products
This classification is based on the nature of the security.
What Is a Financial Security?
A financial security is an instrument that represents a right or a financial relationship between an investor and an issuer. Depending on its nature, it can:
represent an ownership stake in a business
represent a loan made to a government or a company
derive its value from another financial asset
Understanding this distinction is the first step toward understanding the world of investing.
Equity Securities
Equity securities represent an ownership stake in a business. The best-known example is a stock.
By buying a stock, an investor becomes a shareholder and can benefit from:
the company's growth
dividends, if the company pays them
an increase in the value of their investment
In exchange, stock values can fluctuate significantly depending on the company's results and market conditions.
Examples:
Common shares
Preferred shares
Debt Securities
Unlike stocks, debt securities don't give you an ownership stake. They represent a loan made by the investor to a government, a company, or another organization.
In exchange, the issuer generally commits to:
paying interest
repaying the principal on a set date
Bonds are the best-known debt securities, but this family also includes other instruments.
Examples:
Government bonds
Corporate bonds
Debentures
Treasury bills
Commercial paper
Bankers' acceptances
Some of these securities are used for very short-term investments, while others are meant for longer investment horizons.
Derivative Products
Derivative products are a different category altogether. They represent neither an ownership stake nor a loan. Their value depends on an underlying asset, such as:
a stock
a bond
a stock market index
a currency
a commodity
They're mainly used to manage risk, protect a portfolio, or, in some cases, take a position on how a market will move.
Examples:
Options
Futures contracts
Forward contracts
Swaps
Because of their complexity, these instruments are generally used by experienced investors or financial institutions.
A Common Confusion
It's common to believe that mutual funds or exchange-traded funds (ETFs) are types of financial securities. In reality, they're investment vehicles — they pool multiple financial securities into a single portfolio.
For example, a mutual fund might hold:
Canadian stocks
government bonds
corporate bonds
cash
In other words, a mutual fund invests in financial securities, but isn't itself a financial security in the way a stock or a bond is.
The Key Differences at a Glance
Category
What it represents
Examples
Equity securities
An ownership stake in a business
Common shares, preferred shares
Debt securities
A loan made to an issuer
Bonds, Treasury bills, debentures
Derivative products
An instrument whose value depends on another asset
Options, futures contracts, swaps
Key Takeaways
✔ Financial securities can be classified according to their nature
✔ Stocks represent an ownership stake in a business
✔ Bonds and other debt securities represent a loan made to an issuer
✔ Derivative products derive their value from an underlying asset
✔ Mutual funds and ETFs aren't basic financial securities: they're vehicles that pool different securities together
Conclusion
Understanding the main financial securities is essential before moving on to more complex investment products. Once you have this foundation, it becomes much easier to understand how mutual funds, ETFs, and other investment solutions actually work.
In our next article, we'll look at another way of classifying these securities: by the market they belong to, namely the money market, the bond market, and the equity market.
Want to deepen your investment knowledge? On ficexamen.ca, we regularly publish educational articles to make financial concepts simpler and more accessible.