A secondary market is a marketplace where already issued securities – both shares and debt – can be bought and sold by the investors. So, it is a market where investors buy securities from other investors, and not from the issuing company.
When a company issues its securities for the time, it does it in the primary market. After the IPO (Initial Public Offering), those securities get available for trade in the secondary market. Stock markets such as the New York Stock Exchange (NYSE) and the NASDAQ are examples of the secondary markets.
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Features of Secondary Market
- Gives liquidity to all investors. Any seller in need of cash can easily sell the security due to the presence of a large number of buyers.
- Very little time lag between any new news or information on the company and the stock price reflecting that news. The secondary market quickly adjusts the price to any new development in the security.
- Lower transaction costs due to the high volume of transactions.
- Demand and supply economics in the market assist in price discovery.
- An alternative to saving.
- Secondary markets face heavy regulations from the government as they are a vital source of capital formation and liquidity for the companies and the investors. High regulations ensure the safety of the investor’s money.
Major Instruments and Players in Secondary Market
The secondary market deals with fixed income, variable income, and hybrid instruments.
Hybrid instruments are preference shares and convertible debentures.
Major players in the market are Brokerage and Advisory services (commission broker, security dealers and more); Financial Intermediaries (Banks, Insurance companies, Mutual Fund, Non-Banking Financial companies); and retail investors.
Types of Secondary Markets
There are two types of secondary markets:
It is a marketplace, wherein there is no direct contact between the buyer and the seller, like NYSE or NASDAQ. There is no counterparty risk as an exchange is a guarantor. Also, heavy regulations make it a safe place for investors to trade securities. However, investors face a comparatively higher transaction cost due to exchange fees and commission.
Over-The-Counter (OTC) Markets
It is a decentralized place, where the market is made up of members trading among themselves. Foreign exchange market (FOREX) is one such type of market. There is more competition among the participants to get higher volume, so prices of security may vary from seller to seller. Also, OTC markets suffer from counterparty risk as parties deal with each other directly.
Pricing in Secondary Markets
In the primary market, the price of a security is set beforehand. However, in the secondary market, the price of a security is determined by its supply and demand. For instance, if most of the investors believe that the stock would gain going ahead, the demand for that stock goes up, and hence, its price. Similarly, if investors feel the stock will lose value, they will want to sell it, resulting in a price drop.
Importance of Secondary Markets
- It is a good indicator of a country’s economic condition. A rise or drop in the stock market suggests a boom or recession in an economy.
- It helps in valuing a company as economic forces of supply and demand determine the prices.
- Ensures liquidity for the investors as one can easily buy or sell the securities.
- It gives investors a chance to use their idle money to earn some returns.
- It helps the company to monitor and control public perceptions.
Secondary and Primary Market – Difference
- When a company issues IPO, it sells its stock in the primary market. After the IPO, the shares start to trade in the stock markets.
- Proceeds from the sale of shares in the primary market go to the issuing company. In the secondary market, proceeds go the investors selling the security.
- Small investors, usually, don’t buy the securities in the primary market because issuing company sells in lots, which requires a big investment. In the secondary market, however, investors can buy any number of stocks they want.
- Price of securities doesn’t fluctuate in the primary market, unlike in the stock market.
- Issuing company hire investment banks to manage their IPO in the primary market. In the secondary market, investors hire brokers to carry their trade.