What is Secondary Market in Stock Market?

Introduction

The Secondary Market where previously issued financial instruments, such as stocks, bonds, and derivatives, are bought and sold by investors is referred to as the secondary market. It differs from the primary market, where new securities are first issued and offered for sale to the general public.

What is secondary Market?

A secondary market is a marketplace where investors can exchange company shares. It implies that stock transactions between investors are unrestricted and independent of the issuing company. The issuing company does not take part in income generation in these investor transactions; rather, the value of its shares is determined by how well it performs on the market. Thus, in this market, income is produced through the transfer of shares between investors.

Among the organizations that can be found in a secondary market are:-

• Retail buyers
• Advisory service providers, which include, among others, security dealers and commission brokers.
• Financial intermediaries including non-banking financial companies, insurance companies, banks and mutual funds

KEY TAKEAWAYS

• Investors trade with one another in secondary markets as opposed to the issuing entity.
• The secondary market influences the price of securities toward their true value through a vast network of separate but connected trades.

Different Instruments in the Secondary Market 

Fixed income, variable income, and hybrid instruments are the types of instruments traded in a secondary market.

Fixed income instrument:-

A regular form of payment, such as interest, is guaranteed by fixed income instruments, and the principal is repaid at maturity. Debentures, bonds, and preference shares are a few examples of fixed income securities.

Debentures are unsecure, or not secured by collateral, debt instruments. Debenture returns are thus reliant on the credibility of the issuer.

Regarding bonds, they are essentially a contract between two parties that is issued by a government or business. As investors purchase these bonds, the issuing entity is able to obtain a sizable sum of money in this way. Investors receive interest payments at regular intervals, and at maturity, the principal is returned.

Dividends are paid to people who own preference shares in a company before they are paid to equity shareholders. Preference shareholders are entitled to payment prior to other shareholders in the event that a company files for bankruptcy.

Variable income instrument:-

The amount of the effective rate of return that the investor receives from investments in variable income instruments depends on a number of market factors. These investments expose investors to greater risks and greater rewards. Equity and derivatives are two examples of instruments with variable income.

Instruments that enable a business to raise capital include equity shares. Additionally, in the event of a company’s liquidation, equity shareholders have a claim to both the company’s assets and net profits.

Derivatives are a type of contract that involves payment for specified performance and involves two different parties.

Hybird instrument:-

Hybrid financial instruments are created by combining two or more different financial instruments. One type of hybrid instrument is convertible debentures.

Convertible debentures are available as loans or debt securities that, after a set time period, may be converted into equity shares.

Functions of Secondary Market

• A stock exchange offers investors a platform for trading bonds, shares, debentures, and other financial instruments.
• The market permits active trading, allowing for immediate purchase or sale with little price variation between different transactions. Transactions can be entered into at any time. Additionally, trading is continuous, increasing the liquidity of the assets traded on this market.
• Investors locate a suitable venue, such as a regulated exchange, to sell their holdings. They can sell the securities they own on a variety of stock exchanges.A secondary market serves as a medium for deciding how much assets should be priced in a transaction in accordance with supply and demand. Investors can make informed decisions because the public has access to information about transaction prices.
• It also provides a connection between savings and investment and is a good indicator of a country’s economic health. As in, investments made using securities are a means of utilizing savings.

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 interaction between the buyer or seller. Examples of such platforms include 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 higher transaction cost, in the form of commission and exchange fees, is imposed on investments to provide such a safety net.

Over-the-counter(OTC):-

Decentralized over-the-counter markets consist of participants trading among themselves. OTC markets still have higher counterparty risks because there is no regulatory oversight and everyone is dealing with each other directly. An example of an over-the-counter market is the foreign exchange market (FOREX).

There is fierce competition to acquire more volume in an OTC market. This causes the price of the securities to vary between sellers.

Other varieties of secondary markets, in addition to the stock exchange and OTC market, include the auction market and dealer market.

In essence, the former serves as a platform for buyers and sellers to agree on the price at which the securities will be traded. The bidding price of the offer is included in the pricing information that is made available to the general public.

Another kind of secondary market is the dealer market, where different dealers offer prices for particular securities in exchange for a transaction. Bonds and foreign exchange are primarily traded in a dealer market.

Advantages of Secondary Market

Transactions on the secondary market have a number of benefits for buyers, sellers, and the entire financial system. Some of the main benefits are as follows:

• Liquidity

Investors have access to liquidity through the secondary market, which makes it simple for them to buy and sell previously issued securities. As a result, investors can more easily modify their portfolios in response to shifting market conditions and have quick access to cash if necessary.

•  Price discovery

By enabling investors to trade securities in accordance with the supply and demand dynamics of the market, the secondary market facilitates price discovery. This makes it possible to guarantee that securities are fairly valued and that investors get a return on their investment.

• Transparency

Transactions on the secondary market are frequently transparent, and investors can easily find out information about the securities, the issuers, and the trading volume. This makes it possible for investors to make well-informed decisions about their investments.

• Risk transfer

By purchasing and selling securities, investors can transfer risk using the secondary market. A stock owner who is worried about a possible market decline, for instance, may sell their stock to another investor and transfer the risk to the new owner.

• Capital raising

It can also make capital raising easier by enabling businesses to issue new securities to attract investors’ money. This can be accomplished through add-on or supplementary offerings.

• Diversification

It offers a variety of investment opportunities, enabling investors to diversify their portfolios and possibly achieve higher returns.

Disadvantages of the Secondary Market

• Volatilit

The prices of securities can change quickly on the secondary market as a result of shifting market conditions, investor sentiment, and other factors. Due to the uncertainty this can cause, it may be challenging for investors to estimate the value of their investments.

The secondary market is susceptible to price manipulation, including insider trading and other dishonest practices, which can hurt investors and cause price distortion.

• Counterparty risk

Investors are exposed to counterparty risk, or the risk that the other party to the transaction won’t fulfill their obligations, in transactions on the secondary market. In over-the-counter (OTC) markets where there is no central clearinghouse to ensure trades, this can be especially problematic.

• Access

Access for individual investors may be hampered by the possibility that some secondary markets are only open to specific types of investors, such as accredited or institutional ones.

• Regulatory risk

Government agencies have the authority to regulate secondary market transactions, and any changes to these regulations may have an impact on how the market operates and how much a security is worth.

• Price discrepancies

It’s possible that a security’s secondary market price does not always accurately reflect its intrinsic worth or future prospects, which can lead to misalignments and differences between market prices and underlying values.

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