If you look at the balance sheet in a company’s annual report, you may notice some interesting entries listed among its assets. “Trading securities” or “trading account assets” are a special class of investments -- including stocks and bonds -- and are treated quite differently than most other assets a company holds. In fact, U.S. accounting rules require companies to classify the intent at acquisition of any stocks or bonds to accurately value them for accounting and tax purposes.
While many types of companies own equities or bonds as part of their assets, trading securities are a special class of asset used by a company -- mainly financial institutions -- to create profits by buying and selling, rather than holding the security for any length of time. Generally, trading securities are held for very short periods of time, possibly only hours or days, depending on the security and the market.
The Balance Sheet
You'll find trading securities listed on a company's balance sheet in the current assets section. Trading securities are very liquid and easily valued. You may also see an entry in the liabilities portion of the balance sheet called “trading account liabilities,” which indicates that the company has a net short position in certain securities held for trading purposes.
Trading securities are marked to market, which means reported at fair market price at the time the balance sheet is prepared. If the value changes between purchase and the date of the financial statement, the income statement will show an entry for unrealized gain or loss associated with the trading securities.
Other Types of Securities
The two other main classifications for securities are “available to sell” -- stocks, bonds or other financial instruments the company is ready to sell to generate cash, but which are intended for longer holding periods. “Held-to-maturity” securities are long-term debt investments, often not liquid, that the company keeps until maturity, at which time it receives the face value of the bond. Both types of securities may provide an income stream of dividends and bond coupon (interest) payments. Investment securities are reported at market value, while HTM securities are reported at purchase cost on the balance sheet.
Trends in Trading Accounts
Many financial institutions have reduced the amount of assets held for trading purposes. Lower returns in the market, along with increased volatility and uncertainty, have led financial institutions to reduce balance sheet risk from financial market movements. While researching investment options, check the balance sheet and income statements of financial institutions for both the amount of assets in the trading account, and the extent of unrealized losses they may have generated, to determine the company’s true financial health.
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