Key Takeaways
- Marketable securities put capital to work, even as they maintain ready liquidity.
- Marketable securities tend to fall into two main categories, equity and debt.
- The most common types of marketable securities include stocks, bonds, preferred shares, and exchange traded funds (ETFs).
Financial instruments capable of being traded, or those that are readily convertible into cash, are referred to as marketable securities. As essential investment classes, marketable securities tend to be favored by corporations and institutional investors as well as individual investors. They can take the form of either debt or equity. The key is that they can be readily liquidated should the need arise, which is the primary reason companies use marketable securities as investments.
Understanding Marketable Securities
Holding onto cash does little to advance the earnings of a company, institution, or individual. Yes, it is prudent to keep a certain amount of cash on hand to deal with day-to-day needs. However a dollar uninvested is a dollar that could be earning more dollars. Investing in marketable securities offers the potential to realize a gain on cash that would otherwise be sitting idle.
In other words, the high liquidity of marketable securities affords the investor an opportunity to earn a financial return on cash that would otherwise be doing nothing. Marketable securities can also serve as a hedge against inflation as the value of the dollars invested increases, rather than decreases over time.
Marketable securities typically take the form of publicly traded stocks or fixed income products such as corporate bonds and government debt. In the case of the latter two, the maturity date is typically less than one year.
Benefits and Inconveniences of Marketable Securities
These highly liquid investments allow their holders to make money that can be withdrawn quickly, should the need present itself. Moreover, they are not counted as income until they are sold.
This means that fluctuations in price can be counted at the market rate. Should the price decline, the amount can be counted as a loss on the company’s income statement, thus reducing its tax liability. Short-term investments of this nature tend to be low risk, making them a relatively stable means of putting cash that might be needed at a moment’s notice to work. These investments also help diversify a company’s income stream, which can be of benefit during periods of market volatility.
On the other hand, the rate of return reflects the degree of risk these investments entail. Because the risk is low, the return will be low as well. Further, all investing does involve a degree of risk. Any short-term decline in these investments hold the potential to reduce the amount of operating capital, as well as the company’s net income.
Examples of Marketable Securities
Marketable securities generally fall into one of two categories: equity marketable securities and debt marketable securities.
Equity marketable securities afford the holder ownership rights in the company against which they are issued. Debt marketable securities function more like loans to their issuers. They promise to pay a fixed amount in exchange for having use of the capital for a certain period. That time frame is generally one year or less If the debt is to qualify as a marketable security.
With that in mind, marketable security examples include common stock, preferred stock, bonds, and exchange-traded funds (ETFs). Other marketable securities include money market instruments, derivatives and indirect investments.
Treasury bills, banker’s acceptances, purchase agreements, and commercial paper are the money market instruments most often employed as marketable securities. Derivatives — investments dependent upon the value of other securities — include futures, options, stock rights and warrants. Indirect investments often employed as marketable securities include hedge funds and unit trusts.
Marketable vs Non- Marketable Securities
As we have already covered, marketable securities can be readily convertible into cash because they are actively traded in secondary markets open to all types of investors. This means their ownership can be easily transferred and the marketplace establishes their values. Marketable securities are also indicative of the amount of capital their holder has on hand. Because they mature quickly and can be readily exchanged for cash, marketable securities are considered liquid.
Non-marketable securities tend to be more difficult to obtain because they aren’t bought or sold in the public markets. On the other hand, they are also less prone to volatility arising from market fluctuations, because they tend to have little market correlation. Generally speaking, assets falling under this heading include specific types of Treasury bonds, as well as U.S. savings bonds, rural electrification certificates, state and local government series securities, and government account series bonds. Some of these are non-transferable or subject to ownership restrictions. In most cases, non-marketable securities are bought directly from the issuer or over the counter.
Balance Sheets and Marketable Securities
In most instances, marketable securities are listed on corporate balance sheets as current assets and are calculated under the heading of working capital. They can usually be found under the cash and cash equivalents accounts in the current assets section. However, they can also be found in the current assets section as marketable securities. Long-term marketable securities can be found in the non-current assets section.
Thus, the formula for calculating marketable securities is:
Marketable securities included in “cash equivalents” in the current assets section + Marketable securities listed in the current assets section + Marketable securities listed in the non-current assets (long-term assets) section = Marketable securities.