Investment Banking Essentials: Buying and Selling Securities

Securities are financial instruments representing ownership of a company (equities) or a debt obligation (debt securities). They are traded on financial markets, allowing investors to buy and sell them. In this article, I will discuss securities trading in detail and cover the various processes and considerations associated with buying and selling securities.

If you wish to become an expert in securities trading, you should enrol in one of the best investment banking courses available, such as the Certified Investment Banking Operations Professional course by Imarticus Learning. 

Types of Securities

Before discussing securities trading, let us first go through the two types of securities financial instruments overview in brief. These two are the equity and debt instruments.

Equities

Equities represent ownership in a company, offering the potential for high returns and higher risk. Here are two types of equities:

• Common Stock: Represents ownership in a company, giving shareholders voting rights and the potential for capital appreciation.
• Preferred Stock: A hybrid security with characteristics of both debt and equity. It offers fixed dividends and priority over common stockholders in liquidation.

Debt Securities

Debt securities are loans to a company or government that provide fixed interest payments and lower risk but also lower potential returns. Here are two types of debt securities:

• Bonds: Debt instruments issued by corporations or governments to raise capital. Bondholders receive periodic interest payments and the principal amount at maturity.
• Notes: Similar to bonds, but typically have a shorter maturity period.

The Role of Investment Banks

Investment banks are financial institutions that facilitate the buying and selling of securities. Securities trading is one of the investment banking basics. They play a crucial role in the capital markets by:

1. Underwriting: Issuing new securities on behalf of corporations and governments.
2. Brokerage: Executing buy and sell orders for clients.
3. Trading: Buying and selling securities for their account.
4. Mergers and Acquisitions: Advising companies on mergers, acquisitions, and divestitures.
5. Research: Providing analysis and recommendations on securities.

The Securities Trading Process

Order Placement

• Market Order: Buy or sell a security immediately at the best price.
• Limit Order: Buy or sell a security at a specified price or better.
• Stop Order: Buy or sell a security when it reaches a specific price level.

Order Execution

• Broker-Dealer: An intermediary that facilitates the trade.
• Trading Platforms: Electronic systems used to execute trades.
• Trading Venues: Exchanges and over-the-counter (OTC) markets where trades occur.

Settlement

• Clearing and Settlement: The process of confirming and finalising trades.
• Clearing Houses: Institutions that guarantee the performance of trades.
• Settlement Date: The date on which ownership of securities and funds is transferred.

Key Concepts in Securities Trading

• Bid-Ask Spread: The difference between the highest price a buyer is willing to pay (bid price) and the lowest price a seller is willing to accept (ask price).   
• Market Depth: The number of buy and sell orders at various price levels.
• Market Liquidity: The ease with which a security can be bought or sold without having a sizable effect on its price.
• Market Impact Cost: The cost of trading a large quantity of security, which can move the market price.

Risk Management in Securities Trading

Market Risk: The risk of losses due to adverse movements in market prices.

Credit Risk: The risk of default by the issuer of a debt security.

Liquidity Risk: The risk of not being able to buy or sell a security quickly at a fair price.

Operational Risk: The risk of errors, failures, or fraud losses.

Risk Mitigation Strategies

1. Diversification: Spreading investments across different asset classes and securities.
2. Hedging: Using financial instruments to offset potential losses.
3. Risk Management Tools: Employing quantitative models and techniques to assess and manage risk.

Regulatory Framework

Various government agencies regulate securities trading to ensure market integrity and protect investors. Key regulatory bodies include:

• Securities and Exchange Commission (SEC): The primary regulator of U.S. securities markets.
• Financial Industry Regulatory Authority (FINRA): A self-regulatory organisation that oversees broker-dealers.

Regulatory Concerns and Transparency

Regulators are increasingly concerned about the potential for market manipulation and information asymmetry in external market environments such as dark pools. To address these concerns, regulators have implemented various measures to enhance transparency:

• Trade Reporting: Regulators require dark pools to report trade data to market regulators, increasing transparency and enabling surveillance.
• Best Execution Requirements: Regulators require brokers to seek the best execution for their clients, which may include trading on dark pools and public exchanges.
• Market Access Rules: Regulators have implemented rules to ensure fair access to dark pools, preventing discriminatory practices.

Ethical Considerations in Securities Trading

Investment banking, a high-stakes industry, is fraught with ethical dilemmas. Two of the most prominent are insider trading and market manipulation.

Insider Trading

Insider trading involves using non-public, material information to trade securities for personal gain. This practice is illegal and unethical as it gives an unfair advantage to those with privileged information. For instance, an investment banker who learns about a merger before it's public can profit by buying shares of the target company.

Market Manipulation

Market manipulation involves activities that artificially inflate or deflate the price of a security. This can include practices like pump-and-dump schemes, in which investors artificially inflate stock prices by spreading false information and then selling their shares at a higher price.

Importance of Ethical Conduct and Compliance

Ethical conduct and compliance with regulatory standards are crucial for the integrity of the financial markets. When investment bankers act ethically, they build trust with clients, investors, and the public. This trust is essential for maintaining market stability and ensuring fair dealing.

The key benefits of ethical conduct are:

• Reputation: A strong reputation for ethical behaviour enhances an investment bank's brand and attracts top talent.
• Client Relationships: Ethical conduct fosters long-term, trusting relationships with clients.
• Regulatory Compliance: Adhering to regulations minimises the risk of fines and legal penalties.
• Risk Management: Ethical behaviour reduces the risk of scandals and reputational damage.

Wrapping Up

Understanding the process of buying and selling securities is essential for anyone involved in investment banking. Many market analysis techniques can help firms and investors make the right decisions about trading securities.

If you wish to become an investment banker, the Certified Investment Banking Operations Professional course by Imarticus Learning can help you start your career in this domain.

Frequently Asked Questions

What is the difference between equities and debt securities?

Equities represent ownership in a company, while debt securities represent a loan to a company or government. Equities offer the potential for high returns but higher risk, while debt securities provide fixed interest payments and lower risk but also lower potential returns.

Which is a better investment, equities or debt securities?

The better investment depends on your risk tolerance and investment goals. Equities may be a good option if you are comfortable with higher risk for potentially higher returns. Debt securities may be a better choice if you prefer lower risk and steady income.

What are the different types of equities?

Common stock and preferred stock are the two main types of equities. Common stock represents ownership in a company and gives shareholders voting rights. Preferred stock is a hybrid security with characteristics of both debt and equity. It offers fixed dividends and priority over common stockholders in liquidation.

What are the different types of debt securities?

Bonds and notes are the two main types of debt securities. Bonds are debt instruments issued by corporations or governments to raise capital. Bondholders receive periodic interest payments and the principal amount at maturity. Notes are similar to bonds but typically have a shorter maturity period.