Worthless Securities

Definition

Worthless securities are investments that have lost all their original value and are no longer tradable in the financial market. These could be stocks, bonds, or other types of securities which have no potential for future earnings or capital gains. The reasons for securities to become worthless can be company bankruptcy, merger, or extreme market conditions.

Phonetic

The phonetic pronunciation of the term “Worthless Securities” is: /ˈwərθlɪs sɪˈkyʊrɪtiz/

Key Takeaways

1. Definition: Worthless securities are investments that have lost all value. They can be stocks, bonds, or mutual funds which have depreciated so extensively that they hold insignificant or no market price.
2. Tax Implications: Although worthless securities represent financial loss, they can offer tax advantages. The IRS allows taxpayers to claim capital loss deductions on their tax returns for worthless securities, potentially offsetting capital gains from other investments.
3. Risk Management: Identifying and managing investments in worthless securities is essential to risk management. Early recognition can help investors cut losses. On the other hand, investors must be careful to ensure the security is indeed worthless before declaring it as such to avoid potential penalties.

Importance

The business/finance term “Worthless Securities” is important because it refers to investments that have no value, typically due to the bankruptcy or financial failure of the company in which one has invested. Recognizing worthless securities is crucial for investors and businesses alike as it directly impacts financial decisions and tax filings. From a tax perspective, investors can claim a capital loss for worthless securities, which can potentially offset other capital gains and reduce taxable income. Hence, this term plays a significant role in investment strategy, risk management, and financial planning.

Explanation

Worthless securities are an important concept in finance, particularly in relation to investments and taxation. These securities’ primary purpose, interestingly enough, is to allow for a possible reduction in taxable income. Often, investors end up with worthless securities when a company they have invested in goes bankrupt or otherwise fails to such an extent that its stocks or bonds hold no de facto value. In such cases, the investor can claim a capital loss due to holding worthless securities, which could then be used to potentially offset other capital gains or, depending upon individual circumstances, regular income. This could lower an individual’s tax liabilities, thereby potentially salvaging something from an otherwise total loss. But determination of worthlessness is more complicated than simply identifying a fall in market value. In order to claim a tax loss on worthless securities, the Internal Revenue Service (IRS) requires proof that the security has absolutely no value. It must be totally worthless and not expected to regain any value in future. This is where the role of financial and legal advisers become critical as they help discern genuine cases of worthlessness that conform to the IRS’s criteria, thereby allowing investors to responsibly use these securities to their advantage in tax-related contexts. Remember, securities that have declined considerably in value are not necessarily worthless; the term refers specifically to investments that have zero possibility of returning any capital to the holder.

Examples

1. Lehman Brothers Holdings Inc. – In September 2008, the fourth-largest investment bank in the United States filed for bankruptcy, making all of their securities practically worthless. Those who owned stocks or bonds issued by Lehman Brothers saw their investments become worthless as the bankruptcy essentially wiped out the company’s future ability to meet its financial obligations.2. Enron Corporation: The 2001 collapse of Enron, following revelations of an accounting fraud scandal, is another prime example of worthless securities. Enron’s stock, which had reached a high of US$90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001, leaving investors with worthless shares.3. The 2008 Housing Bubble: The securities tied to US real estate, as well as a vast number of financial derivatives linked to those securities, plummeted in value when the housing market collapsed in 2008. Mortgage-backed securities, particularly those containing subprime mortgages, became virtually worthless in a short span of time, causing massive losses for investors worldwide.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Capital Loss
• Non-performing Asset
• Impaired Asset
• Write-off
• Depreciation

Sources for More Information

• Investopedia
• Internal Revenue Service (IRS)
• MarketWatch
• The Balance