A company can raise funds on the capital market by issuing shares, bonds, debentures, and numerous other financial instruments. On the primary market, these securities are issued for the first time, whereas on the secondary market, equities that have already been issued are traded. This post will assist you in comprehending secondary markets and how they can assist you in achieving your financial objectives.
What is a secondary market?
Secondary Market is a financial market where investors buy and sell securities such as bonds and stocks. The secondary market is also referred to as the aftermarket since transactions occur after the primary market and between secondary investors.
The secondary market is the trading venue for follow-on public offerings, which is the inverse of the main market. Through an initial public offering, trading is conducted for the very first time on the primary market. The NSE (National Stock Exchange), BSE (Bombay Stock Exchange), and the London Stock Exchange are examples of Secondary Market when we are considering trade between investors. Occasionally, it is also known as a follow-on public offering because the transactions occur following an Initial Public Offering (IPO).
In other words, a secondary market is a place where numerous types of securities are traded. In an auction-style or dealer setting, investors buy and sell stocks, bonds, debentures, commercial papers, and government bills. The secondary markets can be either an auction marketplace, such as the stock exchange, or an over-the-counter market (OTC). In the stock market, dealers negotiate prices for the items they desire. In contrast, transactions on an OTC market occur without the use of a stock exchange platform.
How does the secondary market work?
Let’s illustrate this using a secondary market example –
Jaspreet purchases some Reliance Industries shares for Rs. 1000 per share.
Reliance Industries is the market issuer of these shares. After a month of ownership, he intends to sell the Reliance Industries shares to another market participant. Vijay purchases shares from Jaspreet since the pricing is acceptable and he thinks the company to be promising for the future. A transaction between Reliance Industries and Jaspreet is an example of a primary market in the provided scenario. In contrast, the exchange between Pratik and Amit is an illustration of the secondary market.
Here, investors transact with one another as opposed to any issuing institution.
Different instruments in the secondary market
- Fixed Income Instruments
Fixed income instruments are essentially debt securities that guarantee a regular form of payment, such as interest and the repayment of the principal at maturity. Debentures, bonds, and preference shares are examples of fixed-income securities. Debentures are unsecured, or non-collateralized, debt instruments. Thus, the returns provided by debentures are contingent on the credibility of the issuer.
Governments and corporations issue bonds, which are essentially contracts between two parties. As investors purchase these bonds, the issuing corporation is able to acquire a substantial quantity of capital. Investors receive periodic interest payments, and the principle is returned at maturity. Priority dividends are paid to preference shareholders of a firm before equity stockholders. Preferred shareholders have the right to be paid before other shareholders in the event of bankruptcy.
- Hybrid Instruments
Combining two or more distinct financial instruments to generate hybrid instruments. Examples of hybrid instruments are convertible debentures. Convertible debentures are accessible as loans or debt securities that, after a defined period, can be converted into equity shares.
- Variable Income Instruments
Since the very beginning, stocks have been a significant component of a financially aware individual’s investment portfolios. An effective rate of return that variable income instruments produce for their owners is based on certain market circumstances. For instance, stock shares enable businesses to raise capital for expansion or other costs. In the event of liquidation, creditors are entitled to both assets and net income.
Contracts between two parties that specify that one party will deliver a return within a specific time frame are known as derivatives. Although they carry a higher level of risk, these instruments provide investors greater rewards than less risky investments like bonds.
Functions of secondary market
- The secondary market is an excellent way to gauge a nation’s overall economic health. As a result, every significant change in the country affects share prices. Each increase or decrease during economic cycles signifies a corresponding upswing or downswing. The secondary market can be used as a gauge to assess the health and prosperity of the economy.
- Investors can trade bonds, shares, debentures, and other financial instruments on a stock exchange thanks to its trading platform.
- The secondary market permits active trading, allowing for fast purchase or sale with little price difference between various transactions. Transactions can be entered at any moment. Additionally, trading is continuous, increasing the liquidity of the assets exchanged on this market.
- Investors locate a suitable platform, such as a regulated exchange, to sell their assets. They can sell the securities they own on a variety of stock markets.
- A secondary market serves as a platform for deciding how much assets should be priced in a transaction in accordance with supply and demand. Investors can make informed decisions since the public has access to information regarding transaction prices.
- Secondary markets are advantageous for trading because only authorized securities are traded. Prior to including a firm on their trade list, stock exchange authorities verify its valuation. In addition to being safer than other solutions, regulatory bodies exercise stringent oversight. They ensure compliance with regulations, such as those concerning financial reporting standards Therefore, it provides investors with the assurance that they are purchasing from a reliable source.
- The secondary market for securities was established so that investors could easily change their assets into cash when necessary. It provides not only short-term liquidity but also medium-term investments, since you may swiftly convert a long-term investment into one within a shorter period.
Types of secondary market
Stock exchanges and over-the-counter markets are the two main categories of secondary markets.
- Stock Exchange
The trading of securities occurs on centralized stock exchanges without any face to face interaction between the buyer or seller. Examples of such platforms are the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
Trading in securities is governed by strict regulations, which apply to stock exchange transactions. Since a stock exchange itself serves as a guarantee, there is essentially no counterparty risk. A greater transaction cost, in the form of commission and exchange fees, is imposed on investments to provide such a safety net.
- Over-the-Counter
In the twenty-first century, over-the-counter (OTC) markets are an essential tool for risk management. Participants in the unregulated OTC market interact openly. As a result, traders must deal directly with counterparty risks that are not covered by regulations. The Foreign Exchange Market, or FOREX, offers a great illustration of how decentralized trading can improve trade volume. It takes place without regulation while also increasing both parties’ exposure to these innate risks. The primary cause of the pricing discrepancy between sellers is this.
The stock market and over-the-counter markets represent a small portion of the secondary markets. In addition to this type, there are auction and dealer markets. The contract is based on the trading price of the securities. Dealer markets occur when several dealers announce the transaction prices for specific securities. Typically, foreign exchange or bonds are traded on this platform.
Examples of secondary market transactions
When a company issues securities, the securities are created on the primary market. Following issuance, securities are bought and sold on the secondary market. If you purchase newly issued LIC stock, you are purchasing shares on the primary market. Typically, significant investors purchase new shares of stock on the primary market. LIC uses the funds from investors who purchase its new stock to finance its operations.
After the securities are issued, the investors who first purchased them from LIC sell them to profit-seeking investors. When investors begin purchasing LIC shares from one another rather than directly from the corporation, they are engaging in secondary market trading. If the price of Microsoft shares is growing on the secondary market, investors profit from purchasing and selling these shares. Microsoft has already received funding from its equity offering from investors who acquired stock directly from the computer giant on the primary market.
The primary participants in the secondary market are corporations and private individuals, as well as the broker-dealers who facilitate trading. Other significant participants include financial intermediaries such as banks, nonbank financial institutions, and insurance firms, as well as advisory service providers such as commission stockbrokers.
Advantages of secondary market
- Selling their shares on a secondary market is one way for investors to receive the money they require. These valued securities, which are ideal for investors with limited liquidity, are always available for purchase.
- The secondary market is a useful tool for determining what a company’s potential present fair market value might be.
- When new information about the company becomes available, price adjustments for securities happen quickly. As investors continue to make trades for their own gain throughout each day, such fluctuations may occur repeatedly.
- To protect investor capital, the secondary stock market is subject to strict regulation. Since the market offers investors and businesses liquidity and capital generation, the restrictions are strict.
- Investors can mobilise their funds more quickly and conveniently with the help of securities. Securities are a crucial investing tool that facilitates faster money mobilisation without sacrificing safety or risk-taking.
Disadvantages of secondary market
- The prices of securities in a secondary market are prone to a significant degree of volatility, which can result in rapid and unforeseen losses for investors.
- Before purchasing or selling on a secondary market, investors must adhere to the necessary processes, which are typically time-consuming.
- Brokerage commissions that are paid on every time an investor buys or sells a security may cut into their profit margin.
- Investments in a secondary capital market are high risk owing to the influence of many external factors, and the current valuation can change in a matter of minutes.
Difference between primary and secondary market
| Primary Market | Secondary Market |
| In a primary market, the price of a stock issue remains fixed. | The prices of securities traded on a secondary market fluctuate based on demand and supply. |
| Securities are first issued in the primary market. Following issuance, such securities are listed on stock exchanges for trading.
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A secondary market is where previously issued securities are traded. |
| In the primary market, investors purchase shares directly from the issuer. | Investors enter into transactions with one another to buy or sell stocks. As a result, issuers are not participating in such trading. |
| The sale of securities in the main market raises funds for the issuer. | Transactions in this market generate income for investors. |
| Primary markets have no geographical presence, it cannot be attributed to any organisational structure. | In contrast, a secondary market has an organisational presence in the form of stock exchanges. |
| Investment Banks are the intermediary in the issuance of IPO. | Brokers are the intermediary in the secondary market. |
Conclusion
Secondary markets are essential to a well-functioning economy. The secondary market consists of a vast network of multiple transactions. Through this system, and in accordance with the economic dynamics of supply and demand, the individual securities being exchanged are driven toward their fair market value. Individual securities acquire an economic premium. As a result of secondary market activity, practically every market price for real assets and financial assets in the majority of economic sectors is more efficient.
FAQs
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What is National Stock Exchange?
The National Stock Exchange, or NSE, is India’s top stock exchange. The world’s fourth largest, it (based on equity trading volume). It was the first stock exchange in India to offer a screen-based trading system, and it is positioned in Mumbai.
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Which is better primary or secondary market?
They each have separate functions and each has value in its own right. However, based on the kind of investor you are, you should choose which one is best for you.
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Secondary market is risky or not?
Share market investing is perceived as a dangerous endeavor. It necessitates in-depth familiarity with the market’s mechanics. To take advantage of the market, you need to make informed selections and conduct adequate research.
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What is a primary market?
Primary market is a component of the capital market. It facilitates the government, businesses, and other institutions to raise additional funds by selling debt and equity-related instruments. Primary market securities include, for instance, notes, bills, government bonds, corporate bonds, and company stocks.
Blog last updated on 25.03.2023
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