Final answer:
An investor might classify securities as AFS (Available-for-Sale) to maintain flexibility, manage reported earnings volatility, and align with long-term investment objectives. AFS securities are accounted for differently than trading securities, with changes in value affecting equity rather than net income. This makes AFS securities suitable for investors with a focus on long-term value and earnings stability.
Step-by-step explanation:
An investor might choose to classify securities as Available-for-Sale (AFS) instead of trading securities for several reasons. AFS securities provide investors with flexibility in their investment strategy, as these securities are not intended for immediate sale but can be sold if needed. Typically, the intention behind AFS securities is to earn a return through dividends, interest, or long-term appreciation in value.
A key distinction between AFS and trading securities lies in their accounting treatment. AFS securities are recorded at fair value on the balance sheet, with unrealized gains or losses reported as a separate component of equity, not affecting net income until realized. In contrast, trading securities are marked to market with all gains and losses impacting the current income statement, reflecting a short-term investment horizon and greater volatility in earnings. This aspect makes AFS securities attractive for investors looking to manage reported earnings volatility, support long-term investment objectives, and maintain a diversified portfolio without the immediate pressure to sell.
The choice to invest in AFS securities also relates to the broader context of financial capital acquisition. Organizations might not rely solely on their own profits for financial capital due to the potential need for larger investments that exceed current profits, the desire to maintain cash reserves, or the diversification of financial resources. In these scenarios, external financing through the sale of stocks or issuance of bonds becomes a strategic choice.