What is Secondary Market? Everything You Need to Know
What is Secondary Market: Introduction
Taking about today's market, everyone has a different set of investment plans for himself/herself. Some people are investing to increase wealth, while some are trading because it's like bread and butter for them. And in course of trading or investing, we are somehow connected to the market called the secondary market. So in this part, we will be discussing the secondary market and what are the different aspects of it.
Meaning of Secondary Market
Before moving further let us discuss What is Secondary Market?
Secondary Market is a financial market where securities like bonds and shares are bought and sold by investors. The secondary market is also known as the aftermarket because the transactions are done after the primary market and between investors to investors which are secondary.
The secondary market is the platform where trading is done via follow-on public offering which is the opposite of the primary market. In the primary market, trading is done for the very first time through an initial public offering. NASDAQ and London Stock Exchange are some examples of Secondary Market. Sometimes, it is also referred to as a follow-on-public offering as the transactions are done after Initial Public Offer (IPO).
Types of Secondary Market
Aftermarket is classified into 2 types :
- Stock Exchanges - Stock Exchange is a type of Secondary Market where investors do transactions with each other. Stocks Exchanges are heavily regulated so that there is no chance of fraud. Thus we as investors can rely on these exchanges as it is a safe and secure option for everyone who is trading in the secondary market.
Some examples of these exchanges are the Bombay Stock Exchange(BSE) and National Stock Exchange (NSE)
- Over-the-Counter (OTC) Markets - The user case is the same in the case of the Over-the-Counter Market. But the problem is the lack of regulation.
FOREX is one such example of an OTC market.
How does the Secondary Market work?
Let's understand this with an example of the secondary market -
Pratik buys some shares of Reliance Industries at the price of 1000 per share.
Reliance Industries is the issuer of these shares in the market. After holding the shares of Reliance Industries for a month he plans to sell the shares to another investor in the market. Amit buys the shares from Pratik as the price of shares is reasonable and he finds it interesting for the future.
In the given case, a transaction between Reliance Industries and Pratik is an example of a primary market. Whereas the transaction between Pratik and Amit is an example of the secondary market.
Here, investors do transactions with each other rather than with any issuing entity.
What is Secondary Market: Features of Secondary Market
Following are the features of Secondary Market :
- Creates Liquidity- Secondary Market creates liquidity by converting securities into cash.
- Stock Exchange- Stock Exchange is a particular place for Secondary Market. It is not necessary that every time individuals can trade through the stock exchange they can also do this mutually. Well doing this mutually is also called a transaction of the Secondary Market.
- Encourage Investors- Secondary Market encourages new investors by giving them the freedom of earning profit and transacting mutually.
Types of Instruments in Secondary Market
We have discussed Secondary Market meaning, features of the Secondary Market and its times to know about the types of instruments in the secondary market:
- Fixed Income Instruments - These instruments generate a fixed amount of income at a fixed rate. Bonds, Debentures, and Preferences share are some examples of it.
- Variable Income Instruments - This instrument generates variable income in which the amount of income and rate is not the same.
- Hybrid Income Instruments - Hybrid instruments are convertible instruments. Let's say debenture is converted into shares.
Functions of Secondary Market
Following are the functions of Secondary Market:
- Maintaining the fair value of stocks- With the help of demand and supply in the market, the secondary market attains an equilibrium point (the point where demand matches supply), and this lead to the fair value of stocks.
- Portfolio Adjustment- Secondary market helps investors in choosing shares for buying and selling and this leads to the building of a solid portfolio.
- Capital Allocation- Secondary Markets help in the allocation of capital by signaling the prices of shares which is yet to be released from the Primary to Secondary Market.
Advantages of Secondary Market
- Secondary Markets help companies in identifying their value.
- The secondary market is regulated so that there cannot be a chance of fraud and the funds of investors will be safe.
- Investors can easily liquidate their investments by selling them into the secondary market.
Disadvantages of Secondary Market
- The secondary market has high volatility and price fluctuations and this leads to high risk.
- Investors of secondary markets are liable for extra charges like commissions and tax.
- Investors have to go through paperwork before entering into transactions.
Differences between Primary and Secondary Market
|Basis||Primary Market||Secondary Market|
|Meaning||It is a financial marketplace where companies issue shares for being contributed and in return public buys the shares of the company.||It is a financial marketplace where shareholders of one company trade the shares to other investors in the market.|
|Type of Purchase||Direct||Indirect|
|Parties||Company to investors||Investor to Investor|
|Known as||New issue market||Aftermarket|
Investments will keep you safe from any uncertainty in the future. And Secondary Market is a good investment place where you can generate a good amount of return for yourself. You can take the benefit of price fluctuations and make a handsome amount of money for yourself. But it is advisable to do proper research before investing in any kind of market or instrument.
What are the advantages and disadvantages of the secondary market?
- Indicates fair value
- Mobilization of fund
- Highly volatility
Which is the better primary or secondary market?
Look it depends on the investor to investor if you are someone who prefers to go for IPOs then goes for Primary Market. Whereas if you are someone who likes FPOs then do checkout Secondary Market.