What is the secondary market?
A company can issue securities in the capital market to raise funds. Securities are sold on the primary market when they are first issued. In other words, securities issued by a company for the first time are sold to the public in the primary market. The secondary market is where securities, which have already been sold in the primary market, are traded among investors. Secondary market consists of both equity as well as debt markets.
Also Read: What is private equity and how does it work?
In the primary market, investors get securities directly from the company, while in the secondary market one investor purchases securities from other investors willing to sell the same. Some of the popular secondary markets are the National Stock Exchange (NSE), the New York Stock Exchange, London Stock Exchange, and the NASDAQ. SEBI is the regulator of the secondary market in India.
NRIs can also invest in secondary market in India. To invest in secondary market in India, schedule a call with NRI investment experts.
- The secondary market is basically a stock market where securities are traded by investors and refers to the National Stock Exchange, New York Stock Exchange, London Stock Exchange, etc.
- In secondary markets, investors deal with each other rather than with the issuing entity i.e company.
Some of the key products available in the secondary market are equity shares, bonds, preference shares, treasury bills, debentures, etc.
Functions of secondary market
Following are the main functions of secondary markets:
- Secondary markets or stock exchange houses verify a company’s value before including them in their trade list. Hence, investors can be confident that they are buying from a trustworthy source.
- Stock exchange houses provide a platform for investors to trade securities, such as equity shares, bonds, preference shares, treasury bills, debentures, etc. without involvement of the issuing companies.
- Transactions can be done anytime and the market allows for active trading for immediate purchase or selling with little variation in price among different transactions.
- Investors can liquidate their holdings through an organized exchange. Securities that you hold can be sold in various stock exchanges.
- Using the secondary market valuation data, investors can get an idea about how much they have invested in securities.
- The secondary market for securities allows investors to easily sell their holdings and exchange them into cash when required.
- The secondary market acts as a parameter of determining pricing of assets in a transaction in line with the demand and supply. The information regarding the transaction price is in the public domain that enables investors to decide accordingly.
- It is a great indicator for measuring the economic health of a nation, and also serves as a link between savings and investment.
Types of secondary market
Primarily there are two types of secondary market – stock exchanges and over-the-counter markets. However, they are a fraction of the secondary market.
- Stock exchange
Stock exchanges are centralized platforms where the trading of securities is executed, without any connection or contact between the buyer and seller. National Stock Exchange (NSE), Bombay Stock Exchange (BSE), New York Stock Exchange (NYSE) and NASDAQ are some examples of such platforms.
Trading of securities in stock exchanges are subject to stringent regulations for the safety of investors transactions. Stock exchanges guarantee trades that have less interstate fraud or manipulation.
- Over-the-Counter (OTC) Market
Over-the-counter (OTC) markets are decentralized markets where participants engage in trading directly with each other. As a result, unregulated OTC market traders have to deal directly with counterparty risks in absence of regulatory oversight.
FOREX or Foreign Exchange Market is an example of the OTC market. As it is an unregulated market, both parties are exposed to inherent risks.
Stock market and OTC constitute only a fraction of the secondary markets. Apart from it, other options like fractional ownership in commercial real estate, auction, etc. are available in the market. Unconventional assets like CRE and unlisted shares offer higher returns than these assets.
Types of instruments listed
Individuals can buy and sell various instruments like fixed income, variable income, and hybrid securities. Depending on the type of instrument traded, there are many types of markets, broadly equity, debt (bonds), and currency exchange rates.
Fixed income instruments
Fixed income assets are primarily debt instruments which guarantee a regular form of payment, such as interest and principal paid on maturity. Debentures, bonds, and preference shares are some of the examples of fixed income assets.
Debentures are unsecured debts i.e. the return generated from them will depend on the credibility of the issuing company.
Bonds are essentially a contract between two parties and issued by a government or company. The issuing entity can secure a large amount of funds from investors who buy these bonds. In return, investors are paid interest at fixed intervals and the principal is repaid on maturity.
Variable income instruments
Investors can achieve an effective rate of return by investing in variable income instruments. However, the rate of return depends on certain market factors. For example, companies issue equity shares to raise money for the expansion or other expenses. Investors get claims over net profit as well as assets if it goes into liquidation.
Derivatives are contracts entered into by two parties wherein one party agrees with another party on offering returns within a fixed period of time. These securities can offer better rewards than more stable investments like bonds, though they are riskier.
A combination of two or more types of different financial instruments form hybrid instruments. Convertible debentures are hybrid investment instruments and they may be converted to equity shares after a predefined period. This type of security can be availed as debt or loan securities and provide multiple benefits for your portfolio.
Examples of secondary market transactions
Following are the examples of secondary market transactions:
In the secondary market, investors engage in transactions of securities with each other, rather than the issuing company. For example, if you want to buy Tata Elxsi stocks, you will have to purchase them from another investor who owns such shares and not directly from Tata Elxsi. The company won’t be involved in the transaction.
Retail and corporate investors engage in buying and selling of mutual funds and bonds in a secondary market.
Advantages of secondary market
Key benefits of secondary market are as under:
- The secondary market is a great indicator of measuring the economic condition of a country. The rise and fall of share prices gives an idea about the boom or recession cycle in an economy.
- It is an effective mechanism for a fair valuation of a company.
- The secondary market helps decide the genuine price of securities, fair market value through basic economic forces of supply and demand.
- There is scope of high liquidity in the secondary market – stocks can be easily bought and sold for cash.
The Indian equity market has become a hot investment destination. Investors made 25-30% annual returns in the last 5-6 years by investing in Pre-IPOs. However, it may be risky to invest your hard-earned money without market research and investment guidelines. SBNRI is an online platform exclusively designed to cater investment and transactional needs of NRIs living around the world. The investment experts at SBNRI guide NRIs throughout the investment process.
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