Guide to Secondary Market

Primary markets help in mobilizing funds through issuance of shares or Bonds/Debentures with a promise that these shares or bonds be sold in the secondary market or stock markets. Any investor holding shares or bonds needs a mechanism through which he can sell these investments. 

Secondary market or stock market is a mechanism which provides an exit route to existing investors to find buyers for their securities at a price determined by the market. In effect, secondary markets are resale markets in which existing securities like shares, bonds can be bought or sold. 

The secondary market is where investors buy and sell securities they already own. It is what most people typically think of as the “stock market,” though stocks are also sold on the primary market when they are first issued. This market provides another great service along with the liquidity. This is known as Price discovery. The price of the securities can be thus known on a continuous basis. This helps the investors to take a decision above for sale or purchase of securities. 

New Issue market or IPO market is also dependent on the secondary market as the issuer of new securities is also aware about the price of the securities they have issued at which they can issue securities based on its demand. On the basis of the sentiments too they can decide about when to issue fresh securities. It is a well-known fact that most of the issues in the primary market take place when the secondary markets are bullish. Transactions that occur on the secondary market are termed secondary simply because they are one step removed from the transaction that originally created the securities in question.In secondary markets, investors exchange with each other rather than with the issuing entity.

Some of the entities that are functional in a secondary market include –

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

Primary vs. Secondary Markets

It is important to understand the distinction between the secondary market and the primary market. When a company issues stock or bonds for the first time and sells those securities directly to investors, that transaction occurs on the primary market. Some of the most common and well-publicized primary market transactions are IPOs, or initial public offerings. During an IPO, a primary market transaction occurs between the purchasing investor and the investment bank underwriting the IPO. Any proceeds from the sale of shares of stock on the primary market go to the company that issued the stock, after accounting for the bank’s administrative fees.

If these initial investors later decide to sell their stake in the company, they can do so on the secondary market. Any transactions on the secondary market occur between investors, and the proceeds of each sale go to the selling investor, not to the company that issued the stock or to the underwriting 

To conclude, Secondary Market:

  • Act as a barometer for micro as well as macro level.  
  • Act as a platform for marketability and liquidity of the outstanding equity and debt instruments.  
  • To provide instant valuation of securities caused by changes in the internal environment of the company and industry factors. Such valuation facilitates the measurement of the cost of capital for the company and the rate of return to the investors of the company’s shares.  
  • To ensure a measure of safety and fair dealing to protect investors’ interest.