The most basic unit of investing is the "security." If you want to manage your portfolio to any meaningful degree you will have to understand what securities are and how the government regulates them.
To start off, here's what you need to know about the class of assets called a "marketable security."
What Is a Security?
To understand marketable securities, we first need to understand the concept of a security.
Securities are a broad category of financial products, defined as any form of non-tangible asset that takes its value from the work of someone else. Per the Supreme Court's holding in Marine Bank v. Weaver as cited by an American Bar Association article:
It includes ordinary stocks and bonds, along with the countless and variable schemes devised by those who seek to use the money of others on the promise of profits… Thus the [definition of the term "security"] is not limited to instruments traded at securities exchanges and over-the-counter markets, but extends to uncommon and irregular instruments.
The term is loosely defined specifically so that the Securities and Exchange Commission can review new products to decide if they meet the standards of a securitized asset and, as a result, fall under the agency's authority. For example, in recent years the SEC has exercised this authority to categorize most blockchain products as regulated securities.
Contrary to some writing on the subject, a security is not defined as a stock, bond or option. It does not necessarily require an ownership share in anything. While the SEC tests products on a case-by-case basis, as a general rule the agency will consider an asset a security if it meets the following criteria:
• The asset is a financial product rather than physical property. For example, a bar of gold would not be considered a security while an ownership stake in a gold mine would.
• The asset derives its value from the money and/or work of someone else. For example, a gift certificate would not be considered a security because it has a fixed face value, while a share of stock accrues value from the labors of the company and so would.
Some of the most classic forms of securities are:
• Shares of corporate ownership such as stocks;
• Debt, such as mortgages and bonds;
• Options to purchase goods or products in the future;
• Commodities contracts;
• Shares of a fund, such as a mutual fund;
• Interest bearing assets such as certificates of deposit.
What Is a Marketable Security?
A marketable security is a form of security that can be sold or otherwise converted to cash within less than one year. These products are considered relatively liquid compared to products that are locked into long-term positions.
To be considered marketable, a security must have a face value or near-face value transaction within the one-year period. There must also be no restriction on liquidating or selling this product within less than a year.
Virtually any product short of a junk bond will have some short-term sale price. If you purchase a 20-year government bond, you could absolutely sell this product less than a year later. However, you wouldn't get its value at maturity. You would get a sale price that balances the high security of this product against the time value of having that money locked up for 20 years.
This is a salable security, but not a marketable security.
Why Do Marketable Securities Matter?
Marketable securities are a measure of how much capital a business can access for any upcoming spending.
When a business calculates its assets and total net worth it has two sections of the balance sheet: Current Assets and Non-current Assets. Anyone who has spent much time overseas might recognize this terminology, as outside of the U.S. most banks also use this language for personal banking. What we call a checking account, the cash intended for immediate access, most other countries call a "current account."
Along with cash holding, a company's current account will include all assets that it could convert into cash for face value within one year. This includes all marketable securities along with any significant property that the company anticipates liquidating in the near future.
A company's non-current account will measure all long term assets that the business either can't or won't sell in the coming year. This typically includes all securities with a longer maturity date as well as any major property that the company doesn't intend to sell right away.
Together this evaluation gives a sense of the company's total holdings and the company's near-term spending power.
It is a valuable figure for multiple forms of analysis. Executives at the company will use it to figure out how aggressively they should spend in the coming year, as well as to understand their flexibility to respond to short-term opportunities. Creditors will use marketable securities when deciding terms on which to extend a loan, as it tells them how easily a company can pay them back without having to devalue assets in a fire sale. Analysts and investors use marketable securities when performing liquidity analyses.
A company will also measure its marketable securities to figure out how many assets it can move from the current to the non-current side of its balance sheet. Over-investing in short term assets can be just as wasteful as under-investing. While a company needs to have enough cash or cash-equivalents to respond to upcoming business expenses, long-term assets typically have significantly higher rates of return. Keeping too much money in marketable securities is wasteful and will mean accepting a lower rate of return for unspent cash that could have been better used elsewhere.
Proper corporate governance, then, looks to find the balance.
Non-Current Marketable Securities
Finally, whether a company marks a product as a marketable security or not may depend on its intentions.
A company might buy a security that could typically be highly liquid but it will intend to keep that product for a longer term. In this case, because the company doesn't intend to sell the asset within the next year, it will list the asset as non-current and will not consider it a marketable security.
A common example of this is when companies purchase shares of another company's stock as part of an acquisition bid.
Shares of stock are highly liquid; you can sell them at any time. As a result, ordinarily a company would consider all of its stock holdings as marketable. However, when a company is trying to acquire a rival it will hold those shares long term and consider them non-marketable.
The same can be said of debt instruments. For example, a bank might extend a 20-year mortgage. How that bank classifies the mortgage will depend entirely on its intentions. Ordinarily this would not be considered a marketable security since it will not fully pay off within the next year. However, if the bank extended this mortgage with the intent to sell it as a securitized asset, it may list the mortgage under current assets and classify the note as marketable.
The mortgage wouldn't meet the standard definition of a marketable security, but the bank will nevertheless build that note's sale price into its business plan and liquidity calculations.
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