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All About Secondary Market

Secondary Market

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 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.

 

 

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.

 

 

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

 

 

 

 

 

 

 

 

Types of secondary market

 

Stock exchanges and over-the-counter markets are the two main categories of secondary markets.

 

 

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.

 

 

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

 

 

 

 

 

 

Disadvantages of secondary market

 

 

 

 

 

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.

 

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

 

 

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.

 

 

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.

 

 

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.

 

 

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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