Non-marketable security refers to a security that is not traded on any major securities exchange. As a result, it is difficult to buy and sell such securities. Non-marketable securities are mainly traded as part of a private transaction.
Non-marketable securities are illiquid securities that do not have an active secondary market and may only trade on over-the-counter exchanges.
Examples of non-marketable securities include U.S. Saving Bonds, investment in limited partnerships, shares of private companies, etc.
Investment in non-marketable securities is ideal for investors with a long-term investment horizon, a guaranteed return, and who have disposable income they will not need until the maturity of the investment.
Attributes of a Non-Marketable Security
1. Highly Illiquid
One of the most important features is that the security has no available market for which to trade or sell it. Since there is insufficient liquidity in the market for such security, in many cases, it has to be held until maturity.
Some types of securities may not be transferable to other individuals and may be required to be held by the registered owner until maturity. For example, U.S. Saving Bonds are required to be held until maturity.
3. High return
Lack of marketability and illiquidity are attributes that make investors require a higher rate of return on non-marketable securities.
The Need for Non-Marketable Securities
Non-marketable securities are primarily issued to ensure stability in ownership of the securities. Other reasons for issuing such a type of securities include the need for a long-term investment horizon.
Non-marketable securities are often issued at a lower price than face value, with the securities being redeemable at face value on maturity. The variance between the face value and issue price of the security represents a higher yield or return for the investor.
Examples of Non-Marketable Securities
Most non-marketable securities are government-issued debt instruments. The following are some examples of non-marketable securities:
Shares of private companies
State government securities
Bonds issued by federal governments
Non-marketable securities such as US Saving Bonds are required to be held until maturity and cannot be resold. Investments in limited partnerships are another example of non-marketable securities that cannot be resold easily due to a lack of availability of buyers. Shares of private companies are also not marketable. However, this is usually not an obstacle unless the owner of the shares wishes to relinquish ownership or control in the company.
Marketable Securities vs. Non-Marketable Securities
The fundamental difference between marketable securities and non-marketable securities is the availability of a secondary market to trade marketable securities. Unlike marketable securities, non-marketable securities do not have an observable market value but have an intrinsic value and a book value.
Unlike non-marketable securities, marketable securities are subject to daily price fluctuations and expose the investor to price volatility. On the other hand, the holder of non-marketable securities is not exposed to the risk of price volatility but must accept the risks associated with the lack of liquidity and transferability.
Use of Non-Marketable Securities
An investor is interested in a long-term investment and is looking to invest to save for his 4-year-old son’s college education. He has two options – invest in U.S. Treasury Bonds with various maturities or U.S. Saving Bonds.
Based on his preferences, needs, and time horizon, U.S. Saving Bonds are better suited for the investor. They are a long-term investment and can be transferred to their son when he turns eighteen years old. Also, the savings bonds carry minimum risk, as they are backed by the U.S. Federal Government.
Should the investor decide to invest in U.S. Treasury Bonds, his investment is exposed to the risk of price volatility. Also, he will have to renew the bonds at the designated maturity of the specific bonds he decides to invest in.
Advantages of Non-Marketable Securities
Non-marketable securities, especially those issued by the government, have negligible default and price risk. It means the investor rarely stands to lose money.
Mostly, investors are issued non-marketable securities at a discount but are redeemed at face value. The differential represents a higher yield or return to the investor with a minimum risk of loss.
Disadvantages of Non-Marketable Securities
Lack of liquidity and marketability represents a challenge for investors in the securities. If the investor needs cash quickly, it might be difficult to liquidate their investments quickly.
Some types of non-marketable securities are non-transferable. If an investor is looking to invest in such securities, they should ensure that they only invest a part of the disposable income that they do not require until the maturity of the investment. Lack of transferability means the securities cannot be bought back when needed.
While non-marketable securities are safe investments that provide for a guaranteed return, their upside is also limited. They do not trade on a secondary market where investors trade on volatility in marketable securities to increase return.
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