Chapter 2: What are Securities and Securities Market?

In common parlance, 'securities' refer to financial instruments that represent an economic claim on an enterprise's assets, earnings, or cash flows. Under Indian law, the legal definition of 'securities' is comprehensively codified under Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA).

According to Section 2(h) of the SCRA, 'securities' include:

1. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.
2. Derivative instruments: Including forward, future, and option contracts on individual stocks, indices, interest rates, foreign currencies, or commodities.
3. Units or other instruments issued by Collective Investment Schemes (CIS): Issued to investors in pooled asset arrangements.
4. Units of Mutual Fund Schemes: Representing fractional undivided ownership of pooled financial investments managed by an Asset Management Company (AMC).
5. Government Securities (G-Secs): Marketable debt obligations issued by the Central Government or State Governments.
6. Rights or interests in securities: Including warrants, rights entitlement (RE) letters, and depositary receipts.
7. Units of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs): Enabling public investment into revenue-generating real estate and infrastructure assets.

Securities must possess the fundamental attribute of marketability—they must be capable of being bought, sold, or transferred in an organized marketplace under agreed contractual conditions.

Financial securities are broadly classified into distinct asset classes based on their economic risk-return profiles, legal ownership structures, and cash flow attributes:

1. Equity Securities (Shares)

Equity shares represent fractional ownership in the equity capital of an issuing corporate entity.

• Economic Nature: Equity investors are co-owners of the business. They share in the company's growth, profits, and enterprise value appreciation.
• Returns: Returns are generated via periodic dividends (declared at the discretion of the Board of Directors) and capital appreciation from rising market prices.
• Risk & Seniority: Equity represents the highest-risk asset class because equity shareholders have residual claims—in the event of corporate liquidation, they are paid only after all secured, unsecured, and statutory debts and preference shareholders have been satisfied in full.
• Governance: Ordinary equity shares carry voting rights, allowing shareholders to elect directors and vote on fundamental corporate decisions.

2. Debt Securities (Bonds and Debentures)

Debt securities represent contractual borrowing by the issuer from investors, establishing a debtor-creditor relationship.

• Economic Nature: The investor acts as a lender, and the issuer acts as a borrower obligated to service interest and repay the principal.
• Returns: Returns are typically delivered via fixed or floating coupon payments (interest) at predetermined intervals, along with principal redemption at maturity.
• Risk & Seniority: Debt securities carry lower volatility and higher claim seniority than equities. In the event of bankruptcy, bondholders and debenture holders rank ahead of equity holders. However, debt is exposed to credit/default risk, interest rate risk, and inflation risk.

3. Hybrid and Structural Instruments

Hybrid securities combine elements of both equity and debt:

• Preference Shares: Carry preferential rights over ordinary equity regarding fixed dividend distributions and capital repayment upon liquidation, but generally do not have voting rights unless dividends remain unpaid for a statutory duration.
• Convertible Debentures: Debt securities that can be converted into equity shares at a predetermined price and timeline (Partially Convertible Debentures or Fully Convertible Debentures).
• REITs and InvITs: Pooled investment vehicles that pass through rental, toll, or tariff cash flows as distributions while trading publicly like equity shares.

The securities market serves as the circulatory system of a modern economy, facilitating capital formation, liquidity, and economic efficiency through several critical channels:

1. Capital Allocation and Mobilization: Individual households frequently hold surplus funds in small increments, whereas industrial corporations, infrastructure builders, and governments require massive, long-term capital. The securities market aggregates fragmented household savings and directs them to high-productivity commercial enterprises.

2. Price Discovery: Organized securities markets operate transparent auction and matching mechanisms that continuously reflect all publicly available information, investor sentiment, earnings expectations, and economic data into the equilibrium price of securities.

3. Liquidity Creation: By providing a secondary market where securities can be converted into cash instantly with minimal transaction costs and slippage, the market encourages long-term investments without forcing investors to lock up their liquidity permanently.

4. Risk Transfer and Diversification: Securities markets enable investors and commercial entities to manage and hedge business, currency, interest rate, and commodity price risks using standardized derivative contracts and diversified collective investment products.