Secondary Market – An Ultimate Guide for Beginners

What is Secondary Market

The primary and secondary markets are the two parts of stock markets. The primary market is more focused on developing and issuing securities, whereas the secondary market is where all the trading occurs.

The Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) function as a secondary market. In this article, we will break down all the elements clusters to secondary markets. 

What is the Secondary Market?

The secondary market is where investors buy and sell securities such as bonds and stocks. In layman’s language, it is the stock market, also called market or follow-on public offerings.

It functions as the place for trading post the initial public offerings (IPO) at the primary market. In the secondary market, the trade happens between investor to investor without the permission/approval of the company.

Apart from stocks, securities like mutual funds and bonds are bought and sold in the secondary market by investment institutes, Asset Management Companies, and corporates.

Difference between Primary Market and Secondary Market:

There are two types of markets to invest in securities:

  • Primary Market 
  • Secondary Market

Primary Market:

Securities are created in the primary market. The companies first offer new stocks and bonds to investors on the primary market. It is often performed through an Initial Public Offering (IPO).

Small investors cannot buy assets in this market as the issuing company, and its investment bankers wish to sell to large investors who can purchase many securities at once. The primary market offers finance for companies issuing securities.

Secondary Market:

Securities are traded on the secondary market. Without the participation of the issuing company, investors buy and sell stocks among themselves. 

Since the issuing companies are not participants in the transaction, the secondary market does not offer to fund them. The money obtained in the secondary market for a stock represents revenue for the investor selling the securities.

Types of Secondary Market:

There are two types of secondary markets:

  • Stock Exchanges
  • Over-the-Counter Markets

Stock Exchanges:

Securities are traded on stock exchanges. They are organized marketplaces where buyers and sellers only interact with the help of brokers.  

The secondary market is a reliable and trustworthy option for all traders; therefore, investors can depend on these platforms.

They are strictly regulated to exclude any possibility of fraud. Due to exchange fees and commissions, transfers have an extremely high transaction cost.

Examples of such platforms are the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).

Over the Counter Markets:

Securities are exchanged between buyers and sellers in a decentralized setting in the over-the-counter (OTC) market.

There is strong competition among sellers for more quantity of stocks, which causes pricing variations between them. The risk is larger than with the stock exchanges because the transaction happens one-to-one.

Different companies have different prices for securities. As a result, not all sellers in an OTC market will always give the stocks the greatest price.

OTC marketplaces are subject to counterparty risk since the parties trading on them are interacting with each other.

An example of an OTC market is the Foreign Exchange Market (FOREX).

Types of Instruments in the Secondary Market:

The instruments that are traded in the aftermarket can be broadly classified into three categories:

  • Fixed Income Instruments
  • Variable Income Instruments
  • Hybrid Instruments

Fixed Income Instruments:

These investments provide a fixed income at a fixed price. These are generally debt instruments that assure a constant payment, like interest or principal paid at maturity.

Examples: Debentures, bonds, and preference shares 

Debentures – They are unsecured debts, which means that the credibility of the issuing company will determine the repayment.

Bonds – These are contracts between two parties issued by an entity or the government. Investors who purchase these bonds can provide the issuing company with a large sum.

In exchange, investors receive interest payments at regular intervals and principal repayments upon maturity.

Preference Share – Individuals who own the preference shares in a company gain benefits before equity shareholders. Preference shareholders have the right to receive payment before other shareholders in the event of insolvency.

Variable Income Instruments:

The investments made in these instruments do not ensure a continuous, stable income. Instead, the rewards fluctuate according to the changes in the market. 

The investment made in this situation carries a significant level of risk, but it also can be very profitable. The returns are generated based on risk and reward considerations.

Examples: Equity and Derivatives

Equity Shares – It refers to a company’s net value. If a company goes into bankruptcy, the investors of equity shares have a right to claim the company’s net profits and assets.

Derivatives – These are agreements between two parties when one party promises to offer returns within a specific period. Although they carry a higher level of risk, these instruments may provide higher returns than less risky investments like bonds.

Hybrid Instruments:

Hybrid financial instruments are created by combining two or more different financial instruments. Convertible debentures are hybrid investment instruments that can be changed into equity shares after a certain period. 

This type of security is available as debt or loan securities and offers numerous advantages for your portfolio.

Convertible Debentures – After a predetermined amount of time, they can be converted into equity shares and serve as principal debt security.

Functions of Secondary Market

The main functions of secondary markets are as follows:

Acts as a Reliable Source – Secondary markets or stock exchanges check a company’s value before listing it on their trade list. As a result, investors can be assured that they are purchasing from a trusted source.

Trading Platform – Stock exchange houses offer investors a platform to trade securities, such as equity, bonds, preference shares, treasury bills, debentures, etc., without the involvement of the issuing companies.

Supports Active Trading – Transactions can be made anytime, and the market enables active trading for quick buying or selling with little price fluctuations across multiple transactions.

Creates Liquidity – Investors can sell their shares on a trading platform. You can sell the securities you own on various stock markets.

Market Valuation Data – Investors can estimate the number of securities they have purchased using secondary market valuation data.

Easy Share Exchange – Investors can quickly exchange their holdings for cash when needed by selling their securities on the secondary market.

Maintaining Fair Stock Value – Secondary markets are benchmarks for determining asset pricing in transactions based on demand and supply. The transaction price is available to the public, allowing investors to make corresponding decisions.

Indicator of a Country’s Economy – It serves as a bridge between investment and savings and is an excellent indicator of a country’s economic well-being.

Benefits of the Secondary Market:

The advantages of the secondary market are:

  • Investors can expect massive profits in a shorter period.
  • The secondary market is useful for determining any company’s potential current fair value.
  • A company can be evaluated successfully in these markets based on the stock price.
  • It is simple to buy and sell in these marketplaces, which guarantees liquidity for investors.
  • Secondary markets can be used to evaluate a company’s financial stability.
  • The secondary stock market is strictly regulated to protect investors’ funds.
  • Investors can use the potential of securities to mobilize their funds more swiftly and efficiently.

Conclusion:

The investments you make today will serve as a strong foundation for your future. The secondary market is an excellent place to make investments and get a fair return on your investment.

It makes stock trading easier and allows the exchange of securities for cash. It is advisable to use a fund manager’s services when investing in unstable situations.

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