Secondary Market: Types, Functions, Benefits & Key Insights
The secondary market refers to the financial market where previously issued securities, such as shares and bonds, are bought and sold. Unlike the primary market, where new securities are sold to the public for the first time, the secondary market deals with trading between investors. For example, if you want to buy a company’s stocks, then you will buy from an existing investor, rather than directly from the company.
What is Secondary Market?
The secondary market is where securities like shares and bonds are bought and sold after they’ve been issued in the primary market. For example, a company wants to raise capital from investors to fund its growth, so it has to apply for an IPO by submitting a prospectus to SEBI. After SEBI’s approval, the company came up with an IPO in the primary market for potential investors. After that, the shares of the companies are listed on stock exchanges like NSE and BSE and available for trading in the secondary market.
The Function of Secondary Market
In the secondary market, the investors get an opportunity to trade securities among themselves without directly involving the company. The brokers and dealers play a key role in making sure the process is smooth, and also take care of the translation process.
How Does the Secondary Market Work?
The secondary market allows buying and selling of securities like stocks, bonds, options, and futures contracts. These securities, issued in the primary market, are traded based on supply and demand. Prices of these securities rise with high demand and fall with low demand, which ensures fair valuation and returns for investors.
There are two main types of secondary markets: exchange-traded markets and over-the-counter (OTC) markets. Exchange-traded markets involve centralised trading through brokers or online platforms, with orders processed via a clearinghouse. OTC markets, on the other hand, involve direct trading with dealers, offering flexibility but with less transparency and higher counterparty risk.
Importance of Secondary Market
- Liquidity: Secondary markets provide an easy way to buy or sell securities, offering liquidity to financial assets.
- Price Discovery: The secondary market helps to determine the fair market prices for securities based on supply and demand.
- Efficient Allocation of Capital: By allowing easier trading, secondary markets help allocate capital more efficiently, supporting economic growth.
- Market Stability: Secondary markets promote stability by helping investors diversify portfolios and hedge against risks.
Types of Secondary Market
- Stock Exchanges: These are organised markets where public companies list their stocks for trading. Here, buyers and sellers interact through dealers or brokers. The exchanges are regulated to ensure safe and secure trading, with minimal counterparty risk. However, transaction costs are higher due to exchange fees and commissions. Examples include the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
- Over-the-Counter (OTC) Markets: These markets are decentralised, with buyers and sellers trading directly with each other. The competition can cause price differences between sellers. OTC markets carry a higher risk compared to exchanges since there is no central authority guaranteeing the trade.
Instruments in Secondary Market
- Fixed Income Instruments: These investments provide a fixed income in the form of regular payments. Some of the examples of fixed-income instruments include debentures and bonds.
- Corporate Bonds: These are debt securities issued by companies in India. Investors buy them to lend money to the company in exchange for interest payments and the return of the principal at maturity.
- Government Bonds: These are debt securities issued by the Indian government to raise funds. Investors can buy and sell these bonds in the secondary market.
- Variable Income Instruments: These investments do not guarantee a fixed income, and the returns vary based on market conditions and various factors.
- Futures: Contracts that obligate buyers and sellers to buy or sell an asset at a predetermined price and time in the future.
- Options: Options are contracts that give the buyer the right to buy or sell an asset at a specific price before a certain date.
- Hybrid Instruments: These offer a combination of fixed and variable returns. One of the examples of it is a convertible debenture.
Aftermarkets Participants of Secondary Market
- Investors: Individuals or institutions that buy and sell securities in secondary markets for investment purposes.
- Brokers: Intermediaries who help facilitate trades between buyers and sellers, charging fees or commissions for their services.
- Market Makers: These intermediaries provide liquidity by buying and selling securities on their own account.
- Regulators: Government bodies that oversee and regulate secondary markets to ensure fair and efficient operation.
Benefits of Secondary Market
Here are some of the benefits of secondary market –
- Liquidity: The secondary market allows investors to buy and sell securities quickly, providing ease of access to cash when needed.
- Price Discovery: The market sets the fair value of a security based on what buyers are willing to pay and what sellers are willing to accept.
- Transparency: Stock exchanges share price information openly, allowing all market participants to see the same data.
- Accessibility: Online brokers make it simple for individual investors to trade securities, making the market more accessible to everyone.
- Market Orders: The market allows different types of orders, such as limit and stop orders, which give traders more control over their investment strategies.
Risks and Challenges of the Secondary Market
There are risks involved in the secondary market as well, such as:
- Market Volatility: Prices of securities can change quickly and unexpectedly, causing instability in the market.
- Insider Trading: This occurs when someone trades based on confidential, non-public information, which gives them an unfair advantage.
- Market Manipulation: This involves actions intended to artificially influence the price of securities, often misleading investors.
- Systemic Risk: This is the risk of a large-scale financial collapse, often triggered by the failure of a major financial institution or a significant event.
- Market Orders: These orders provide flexibility by offering different types, such as limit or stop orders, to help investors manage their trading strategies.
Examples of Secondary Market Transactions
Below is a list of the secondary market transactions:
- Stock Market Transactions: Investors purchase and sell equities of companies listed on stock exchanges such as NSE and BSE. These equities were subscribed during the IPO and are now available for trade in the secondary market.
- Bond Market Transactions: Investors have the opportunity to purchase corporate bonds that were issued by companies to raise capital. These bonds are now available for trade in the secondary market.
- Investments in Mutual Funds: Investors purchase shares of a mutual fund, which includes a mix of stocks and bonds, and are traded in the secondary market.
- Options for Stock Trading: Investors purchase stock call options. These options allow them the opportunity to buy the stock at a specified price within a specified period of time.
- Trading in Futures Contracts: Investors procure futures contracts for commodities such as crude oil or gold. These contracts mandate them to purchase or sell the commodities at a set price on a specified date in the future.
Secondary Market vs Primary Market
Here is a comparison between the primary and secondary markets:
| Aspects of Comparison | Primary Market | Secondary Market |
| Definition | In the primary market, companies issue and sell new securities. | The secondary market allows Investors to buy and sell existing securities. |
| Purpose | Companies raise capital by issuing new shares or bonds | Investors trade pre-issued securities |
| Participants | Issuers (companies) and investors (public, institutions) | Primarily investors (both retail and institutional). Companies may repurchase shares occasionally. |
| Trade Volume | Limited | Higher trading volume |
| Price Determination | Company sets the issue price based on valuation and market conditions. | Prices are determined by supply and demand. |
| Role of Intermediaries | IInvestment banks and institutions underwrite and issue securities. | Stock exchanges and brokers facilitate the trading. |
| Capital Flow | Flows from investors to the issuing company. | Flows between investors in trading transactions. |
To Wrap It Up…
IThe secondary market is an integral part of the financial market. Like India, every country has its own secondary market where investors get an opportunity to buy and sell securities. But secondary market has its own challenges as well, and that’s why it’s important for investors to conduct thorough research and consult a financial advisor before investing in the secondary market.
FAQs
As the primary market is the market where securities are issued for the first time, and on the secondary market, the issued securities become available for trading.
An example of the secondary market could be trading a company’s stock. In the secondary market, an investor can trade company stocks instead of buying directly from that particular company.
An example of a secondary transaction can be a transaction where an early investor sells his shares to some buyer, shares are exercised, or shares are liquidated in a financial round.
The secondary market is also commonly referred to as the aftermarket, where trading is held in stock exchanges like NSE and BSE.
In the secondary market, liquidity is created when investors buy and sell securities, such as stocks. By purchasing shares from a broker and selling them later, this market ensures there’s a continuous flow of assets. It makes things easier for investors to trade.
Prices in the secondary market are decided by supply and demand. When more people want to buy a stock, its price usually goes up. And like that, if more people want to sell, the price tends to drop.
The secondary market helps set the price of assets through supply and demand. It provides essential transaction data, allowing investors to make well-informed decisions based on current market conditions.
An online trading platform for the secondary market allows investors to buy and sell securities like stocks, bonds, and ETFs. One of the examples is smallcase, which offers access to the secondary market and invests in ready-made model portfolios.
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