Marketable Securities: Definition, Types & Examples

KEY TAKEAWAYS

• Marketable securities are liquid financial instruments. 
• They can be converted into cash quickly and at a reasonable price.
• They are low-risk, low-reward stock options.

What Are Marketable Securities?

Marketable securities are liquid financial instruments. They can be converted into cash quickly and at a reasonable price. The reason that marketable securities are highly liquid is that the maturities tend to be less than a year. Also, the rates at which they can be sold or bought don’t have much of an effect on the prices. 

How Do Marketable Securities Work?

A business will tend to hold cash in its reserves. This is to prepare them for any scenario in which they need to act quickly. This could be to take advantage of an opportunity for acquisition or to make contingent payments. 

However, if a business merely keeps a large amount of cash on hand in its accounts, then there is no opportunity to earn interest. This means that the business will be consistently losing out on a potentially significant amount of income. To counter this, a business will invest a portion of its liquid cash into short-term liquid securities. 

This means that the cash isn’t idly sitting and the business can actually earn returns on it. But if there is a sudden need for this cash, the business can easily liquidate the securities and have the cash on hand again. 

A marketable security can be defined as any unrestricted financial instrument that can be sold or bought on a public stock exchange. It can also be purchased on a public bond exchange. That means that marketable securities can be either classified as marketable equity security or marketable debt security. 

It’s also important that marketable securities have a strong secondary market. This means that you can quickly facilitate buy and sell transactions. And if you have a secondary market, it provides a much more accurate price for investors. 

The potential return on these types of securities is low. This is due to the highly liquid nature of the instruments. So they are considered to be generally safe investments.

What Are the Features of Marketable Securities?

There are many different features of marketable securities. But there are two that stand out as the most important that set them apart from the rest. They are as follows:

1. Highly Liquid

A marketable security has to be highly liquid. High liquidity refers to the ability to resell the asset with there being many buyers available to purchase, thus reducing the amount of time to convert the assets into cash.

As these securities are highly liquid, they can easily be converted into cash. This is within a short period and at a reasonable price. There is no actual definition of what counts as a short amount of time, but it is generally accepted that anything less than a year is serviceable. 

Some examples of instruments that are highly liquid are:

• Treasury bills
• Commercial paper
• Bills receivable
• Other types of money market instrument

2. Easily Transferable 

Marketable securities also have to be easily transferable. This is in relation to the stock exchange. So if an instrument is highly liquid, but difficult to transfer, then it would not be considered a marketable security.

3. Marketability

Marketable securities will have an active marketplace where they can be sold and bought. For example, a stock exchange. The marketability of a security is similar to its liquidity. The exception is that liquidity means the time in which a security can be converted into cash. Whereas marketability is the ease at which the security can be bought and sold.

4. Lower Return

The return on any security is directly correlated to the risk that it is associated with. The general rule of thumb is that the higher the risk the higher the return. So seeing as these securities are highly liquid and easily transferable, there is a lower rate of risk that is attached to them. This also means that there is a lower rate of return for the securities.

The Two Main Types of Marketable Securities

There are two main types of marketable securities:

• Equity securities
• Debt securities

Let’s take a closer look at each of these types.

Equity Securities

Marketable equity securities can be common stock or preferred stock. They are the equity securities of a public company that is held by another corporation. They would be listed on the balance sheet of the holding company. 

If it is expected that the stock is to be traded or liquidated within a year, the equity would be listed as a current asset by the company.

Debt Securities

Marketable debt securities are any short-term bonds, treasury bills, or commercial papers that are issued by a public company and held by another company. These securities are normally held by a company instead of cash and will have cashflows distributed or are interest-bearing. They would be classified as current assets.

Further Examples of Marketable Securities

Within equity and debt securities, there are subsections of marketable securities. 

Let’s take a look at some of them.

Stocks

Stock represents an equity investment. This is because shareholders have partial ownership of the company that they have invested in. The company can therefore use shareholder investment as a form of equity capital. This can be used to fund any of the company’s operations and expansions. 

In return for this investment, shareholders receive voting rights and dividends periodically. This tends to be based on the profitability of the company. Investing in the stock market can be a risky move. This is because the value of a company’s stock can wildly fluctuate.

Bonds

Bonds are the most common securities. They are great primary sources of capital for smaller businesses or a business that is looking to grow. A company or government can issue bonds. Similar to a bank loan, a bond will give you a fixed rate of return. This is known as the coupon rate. It is used in exchange for the use of funds that have been invested. 

Bonds are traded on the open market. This means that they can be purchased for less than par value, which is the face value of the bond. Each bond that is issued will have a specific par value, coupon rate, and maturity date. The maturity date is the specified date at which the entity has to repay the full par value of the bond. 

Depending on the current state of the market conditions, bonds can also sell for more than par. This is known as bonds trading at a premium. Coupon payments are based on the par value of the bond, rather than the market value or the purchase price. That means that an investor that purchases a bond at a discount can get the same interest payments as someone who paid the full price.

Preferred Shares

Preferred shares have the qualities of both debt and equity. They have the benefit of fixed dividends that are paid before common stockholders. This makes them more like bonds. But a bondholder still remains senior to a preferred shareholder. 

However, they are unlike a bond in the fact that the initial investment of the shareholder is never repaid. This makes it a hybrid security. Preferred shareholders are granted a more senior claim on any funds if the company goes bankrupt. In exchange for this, preferred shareholders have to give up their voting rights. 

These guaranteed dividends and safety from insolvency make preferred shares a tantalizing investment opportunity. They are particularly appealing to anyone who thinks common stocks are too risky. But they also don’t want to wait until their bonds mature.

Exchange-Traded Funds (ETFs)

ETFs are marketable securities that allow an investor to buy and sell collections of other assets. This includes stocks, bonds, and commodities. They are classified as marketable securities because they are traded on public exchanges. However, ETFs may actually also hold assets that don’t count as marketable securities. This could be things such as gold and any other precious metals.

What Are Marketable Securities in Accounting?

When it comes to accounting, marketable securities are classified as current assets. This means that they are often included in working capital calculations on a company’s financial statements. 

Any business that has a more conservative outlook on its cash management will tend to invest in short-term marketable securities. They would avoid riskier securities as well as any long-term options. This would include stocks and fixed-income securities that have a maturity period of longer than a year. 

Marketable securities tend to be reported under the cash and cash equivalents accounts on the balance sheet of a company. This would be in the current assets section.

Summary

Marketable securities are a great way for businesses to be able to have a large amount of cash at hand as liquid assets. But they are also a great way to ensure that any cash you do have is still making a form of return. 

While they may be low risk, they are also low return. This would mean that they shouldn’t be used as the main form of investment securities. But if you are looking to have a steady stream of low returns, then they are a good option.