What is Listed Security?
Listed securities are Financial Instruments (Stocks, Bonds, Derivatives, etc.), which trade in an exchange. Securities which doesn’t trade in exchange trades via “Over The counter marketOver The Counter MarketOTC markets are the markets where trading of financial securities such as commodities, currencies, stocks, and other non-financial trading instruments takes place over the counter (instead of a recognized stock exchange), directly between the two parties involved, with or without the help of private securities dealers.,” also known as OTC securities. OTC is a dealer marketA Dealer MarketA dealer market is where dealers engage in buying and selling a specific financial instrument using their account electronically without a third party and make the market by quoting the offer price and bid price..
Types of Listed Securities
Different types of securities that trade in an exchange and listing procedure
#1 – Stocks
When a private company has been operating for a few years and wants to raise more capital from the market, then they sell their own and make them public via listing their shares in exchange. Each exchange has specific rules like minimum stockholder’s equity, minimum share price, a minimum number of shareholders, and the minimum number of profitable years as a private held company.
ABC is a private company that is planning to raise more capital from the market by listing its shares in the Stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.. What are the advantages and steps?
There are a few ways to raise capital. If ABC plans to take a loan from the bank, then it will have to pay interest to the bank even if it doesn’t earn a profit. So taking a loan is a fixed liability for ABC. So instead of taking a loan from the bank, if ABC can make its company public by selling of percentage of the owner’s ownership, then that will help ABC to raise money as well as it will not have a fixed liability to pay interest every year. When you make your company public, then it depends on the company’s management, whether they want to pay dividends or not.
Steps to List Shares
- Decide an Underwriter
Decide an Underwriter who will help the private company to get it listed as a public company, as underwriters have licenses to help in the listing process
- Share Price
Underwriters will decide the share price by judging the economic condition and by calculating the future earning the power of the company
- Legal procedures
Several Legal procedures will be met, and the date will be decided for the listing.
The first day, when the shares will be traded in exchange, is called the “Initial Public OfferingInitial Public OfferingInitial Public Offering (IPO) is when the shares of the private companies are listed for the first time in the stock exchange for public trading and investment. This allows a private company to raise the capital for different purposes..” It is done in the primary marketThe Primary MarketThe primary market is where debt-based, equity-based or any other asset-based securities are created, underwritten and sold off to investors. It is a part of the capital market where new securities are created and directly purchased by the issuer.
From the next day, shares are already in the hands of investors, and they start trading shares among themselves in the secondary market.
XYZ Company has 10 Million Authorised shares, 800,000 Issued SharesIssued SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet., and 50,000 Treasury shares. How many shares are outstanding in the market?
Getting authorization to list shares in the market is costly; there are lots of legal works and fees that a company will have to pay. So say a company wants to Issue 1,000 shares in the market now, they will still get authorization of say 1,000,000 shares. Every time before issuing shares, they don’t want to go to the tedious process of getting authorization first.
So here, company XYZ has got Authorisation for 10 million Shares, out of which it has issued 800,000. Out of the issued shares, all shares are not traded in the market; few shares are bought backShares Are Bought BackShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company. and are kept in the treasury for future corporate action needs. So here, 50,000 shares are kept in the treasury. So outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet. in the market are
Outstanding Shares = Issued Shares – Treasury Shares
- = 800,000 – 50,000
- = 750,000
750,000 shares are trading in the market.
The shares price for EFG Company is $50, and there are 1 million outstanding shares in the market. Calculate the market capitalization?
Market Capital = Share Price * Outstanding Shares
- = $50 * 1,000,000
- = 50,000,000
So listed securities help us to calculate the value of the company in the market.
#2 – Bonds
Bonds are also an important way to raise capital for companies. There are several types of bonds having different maturities, coupon ratesCoupon RatesThe coupon rate is the ROI (rate of interest) paid on the bond's face value by the bond's issuers. It determines the repayment amount made by GIS (guaranteed income security). Coupon Rate = Annualized Interest Payment / Par Value of Bond * 100%, options, and face-value. When a company issues a Bond, it is a liability for the company, and it will have to pay the coupon whether the company earns a profit or not.
Getting a bond listed in exchange helps investors to get the liquidity they want from any investment.
ABC Company plans to raise $50 million by issuing bonds of Face value $1 million. With a Coupon rate of 5%. Maturity 10 years. So for this, ABC will have to Issue 50 Bonds in the market with a Face Value of $1 million each. Each year ABC will have to pay interest of 5% * $1 million * 50 = 2.5 million
So any investor who has bought the bond will have to wait for 10 years to get his money back. So the Secondary market helps investors to get the liquidity as they can exchange securities in the secondary market.
A bond “XYZ” is giving Coupon rate of 5%, the interest rate in the market rose to 8%. What will happen to the price of the Bond in the secondary market?
As the bond is listed security, so its price keeps on changing. So if in the market similar bonds are paying a Coupon rate of 8% and bond “XYZ” is paying a coupon 5%, so the demand for the bond in the secondary market will fall as no one will be willing to buy it, and its price will fall.
So the secondary market helps in determining the correct price of a listed security.
#3 – Derivatives
DerivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. are securities that derive their value from an underlying security. There are several types of derivativesTypes Of DerivativesA derivative is a financial instrument whose structure of payoff is derived from the value of the underlying assets. The three types of derivatives are forward contract, futures contract, and options., like OptionsOptionsOptions are financial contracts which allow the buyer a right, but not an obligation to execute the contract. The right is to buy or sell an asset on a specific date at a specific price which is predetermined at the contract date., Swaps in financeSwaps In FinanceSwaps in finance involve a contract between two or more parties that involves exchanging cash flows based on a predetermined notional principal amount, including interest rate swaps, the exchange of floating rate interest with a fixed rate of interest., Forwards, and Futures. Options and Futures are mostly exchange-traded.
ABC Company is trading at $5; what will happen to the call option if the price of ABC Company increases to $10. The strike priceThe Strike PriceExercise price or strike price refers to the price at which the underlying stock is purchased or sold by the persons trading in the options of calls & puts available in the derivative trading. Thus, the exercise price is a term used in the derivative market. of the call option is $8
Soln: Call Options are listed securities. They are right to buy. So whoever buys the call option will have the right to buy ABC stock at $8. So ABC is trading in the market at $10, and whoever buys the option will get the share at $8, so obviously, the price of the option will increase.
As the options are listed, so trading is done, and its price changes with the underlying stock.
Advantages of Listed Securities
Some of the advantages of Listed security are as follows.
- Listing of securities helps incorrect pricing of the securities.
- The secondary market provides liquidity to security, which is beneficial for investors.
- When a company gets listed and becomes public, there are lots of disclosures that the company does on a quarterly or event basis. So it helps in mitigating frauds.
- It helps to provide a transparent market for all investors.
Disadvantages of Listed Securities
Some of the advantages of Listed security are as follows.
- Unnecessary panics can cause a huge fall in share prices.
- Anyone with money power can play with the price of a listed security.
- Making a company public actually takes control out of the previous owner, which in turn delays decision making and good opportunities can be missed
Listed securities are the backbone of the financial marketFinancial MarketThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.. The exchange plays the most important part in giving liquidity to securities, which were earlier illiquidIlliquidIlliquid refers to an asset that cannot be converted to cash. Such assets suffer a valuation loss when sold in exchange for cash. Bonds, stocks and properties are some examples of illiquid investment.. The exchange acts as a bridge between the buyer and seller of financial products.
This has been a guide to what is listed security and its definition. Here we discuss the top 3 types of securities that trade in exchange along with examples, advantages, and disadvantages. You can learn more about financing from the following articles –