Secondary Market: Meaning, Functions & Types

A company can raise money by issuing shares, bonds, debentures, and many more financial instruments in the capital market. The primary market is where these securities are created for the first time while the secondary markets deal with already-issued stocks. This article will help you understand Secondary markets and how they can help you achieve your financial goals.

What is a Secondary Market?

A secondary market is also known as an aftermarket. It is a place where companies can trade their securities. Secondary markets allow investors to buy and sell shares freely without the issuing company’s intervention. Share valuation is based on performance in these transactions. Consequently, the selling of shares between buyers and sellers of stock generates income. 

A secondary market is a bustling place for trading securities of many kinds. Investors buy and sell shares, bonds, debentures, commercial papers, and treasury bills in this auction-style or dealer environment. The secondary markets can be either an auction marketplace like the stock exchange or over-the-counter (OTC). In the stock market, traders haggle over prices for their desired goods. While, in an OTC market trades take place without using the platform of a stock exchange at all.

Companies first offer their securities in the primary market to those with enough funds and an investment plan. Thereafter, the listing of securities takes place in a stock exchange for trading in the markets. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are the stock exchanges in India.

Functions of Secondary Market

Following are the main functions of the secondary markets:

The Economic Barometer

The secondary market is a great indicator for measuring the economic health of an entire country. Therefore, every major change in the nation influences the prices of shares. Each rise or fall represents either an uptick or downtick during economic cycles, respectively. The Secondary Market can be seen as a pulse checker to measure the economy’s health and well-being.

Securities Pricing

Secondary markets are a great asset to investors, the government, and creditors alike. Investors can get an idea of how much they have invested in their securities using secondary market valuation data. Therefore, it is helpful for tax calculations or other financial tasks like borrowing money from a bank. The government benefits because it has more insight into the finances of its citizens. It helps them collect tax revenue accordingly. Instead of being reactive about collecting pending tax amounts, the government refers to the data. Creditors assess valuations which helps them determine the credit-worthiness of a borrower and avoid risks.

Transactions Safety

Secondary markets are great for trading because they trade only authorized securities. Stock exchange authorities verify the company’s value before including them in their trade list. In addition to being safer than other options, there is also strict oversight by regulatory agencies. They ensure companies stay compliant with rules such as those pertaining to financial reporting standards. Therefore, it gives investors the confidence that they are buying from a trustworthy source.

The Contribution to Economic Growth

Secondary markets help to provide a platform for businesses and investors with excess capital. This process of selling some securities in order to invest in others enables you to get good returns. Therefore, you can make the most out of your money by investing it wisely. The flow of investment capital via disinvestment and reinvestment helps ensure efficient use of resources while also reducing economic uncertainty. It leads to growth within individual industries and even across sectors at large. Thus, it plays a role in improving the economy as a whole.

Liquidity

The secondary market for securities was created in order to allow investors to easily sell their holdings and convert them into cash when they need it. It not only provides the benefit of short-term liquidity but also medium-term investments because you can quickly turn your long-term investment back into one that is shorter duration.

What are the Types of Secondary Markets in India?

There are the following two types of secondary markets in India.

Stock Exchange

Stock exchanges are where the trading of securities takes place, without any contact between buyer and seller. The National Stock Exchange (NSE) and The Bombay Stock Exchange (BSE) are examples of such a platform. A stock exchange’s stringent regulations in securities trading provide for the safety of investor transactions. Consequently, the counterparty risk is almost non existent, with a higher transaction cost applicable to investments through commission and exchange fees. These guarantee trades that have less intrastate fraud or manipulation.

Over-the-Counter (OTC) Market

Over-the-counter (OTC) markets are a crucial means of managing risk in the 21st century. Unregulated OTC market participants engage directly with each other. Consequently, traders have to deal directly with counterparty risks that fall outside regulatory oversight. Foreign Exchange Market, or FOREX, provides an excellent example of an increase in trade volume via decentralized trading. It happens without regulation while simultaneously increasing exposure to these inherent risks for both parties. This is the main reason for the price difference between one seller to another.

The stock market and OTC are only a fraction of the secondary markets. Apart from it, two other types exist i.e., auction and dealer markets. Auctions are public platforms for buyers to come together with sellers to strike an agreement. The agreement takes place as per the trading rate of the securities. Dealer markets take place when various dealers indicate the prices of specific securities for transactions. Foreign exchange or bonds trade primarily on this type of platform. 

What are the Types of Instruments Listed on Secondary Markets in India?

A secondary market is a place where you can buy and sell instruments like fixed income, variable income, or hybrid securities. There are many types of markets depending on the type of instrument that trades in them. Broadly, they are equity (stocks), debt (bonds), and currency exchange rates between currencies.

Fixed Income Instruments

Fixed-income assets are primarily debt instruments. They guarantee a regular form of payment, like interest and principal repayment at maturity. They also include debentures, bonds, and preference shares. However, Debentures are unsecured debts, which means the return generated is dependent on an issuer’s credibility. Whereas, they do not require collateral. If the company goes out of business, it can decide to not pay its obligations. Unless there’s another agreement in place outside bankruptcy court about how or when payments will be made.

In their most basic form, bonds are financial instruments a government or company issues to lenders. They are contracts that allow an issuing entity to secure funds from investors. The company pays back the amount at predetermined intervals with interest in the meantime. This is usually done through two parties, i.e., the issuer and the investor. The person who wants money is the issuer. An investor is an individual wanting a return on investment without undertaking much risk. This system allows individuals to invest with the knowledge that it will give them some return.

Investors buy preference shares in order to receive dividends before equity shareholders do. That means if you own a company’s stock as a preferential investor, you get your returns first. Even when the company faces bankruptcy, priority goes towards obligations due to its ownership structure. Therefore, creditors get paid back first, while bondholders and ordinary shareholders have second and third claims, respectively.

Variable Income Instruments

Ever since the first stocks were sold to investors, they have been a major element of investment portfolios. Variable income instruments generate an effective rate of return to their owners and certain market factors determine this amount. For example, equity shares allow companies to raise finance for expansion or other expenses. At the same time, people get claims over net profits as well as assets if it goes into liquidation.

Derivatives are contracts between two parties where one party agrees with another on delivering a return within a set period. These securities expose investors better rewards than more stable investments like bonds, though they are riskier.

Hybrid Instruments

Convertible debentures are hybrid investment instruments that may be converted to equity shares after a predetermined period. This type of security is available as either debt or loan securities and can provide multiple benefits for your portfolio.

What are the Advantages of the Secondary Market?

The main advantages of secondary markets are as follows:

• Investors can get the cash they need by selling their shares in a secondary market. Buyers are always present to purchase these valuable securities, which are perfect for investors who may be tight on liquidity.
• The secondary market is a valuable indicator of what the current fair valuation for any company might be.
• Price adjustment of securities is a swift process when new information about the company becomes available. Such changes can happen over and over throughout each day as investors continue to make trades for their own benefit.
• The secondary stock market is heavily regulated to keep investor’s funds safe. The regulations are stringent as the market provides liquidity and capital formation for both investors and companies.
• With the power of securities, investors can mobilize their savings more quickly and easily. Securities are an important investment vehicle that allows for the quicker mobilization of funds without compromising on safety or risk-taking.

What are the Limitations of the Secondary Market?

• The prices of securities in a secondary market are subject to high volatility. Price fluctuations may lead to sudden or unpredictable losses for investors.
• Buying and selling in a secondary market can be time consuming. Investors have to deal with the tedious paperwork involved before completing final transactions.
• Investors must be careful with their brokerage commissions because they are taxed every time the trade is made. Commissions can have a huge impact on investors and may even dent your profit margin if you’re not paying attention.
• Multiple external factors influence the investments in a secondary capital market thereby subjecting them to high risk. These may lead investors’ existing valuations to change rapidly within seconds.

What is the Difference Between Primary Market and Secondary Market in India?

Following are the key differences between Primary Market and Secondary Market in India:

	Primary market	Secondary market
Alternate name	New Issue Market (NIM).	After Issue Market (AIM).
Role	Securities are issued for the first time.	Already issued securities are traded.
Intermediaries	Investment banks.	Brokers.
Sale of securities	Companies directly transact with the investors.	Sale and purchase transactions take place among investors and traders without the involvement of the issuer.
Price of shares	The stock price is fixed at par value.	Stock Prices change depending on the supply and demand of shares.
Income generation	Sales of securities help in raising funds for the issuer.	Transaction of securities generates income for investors.

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