Secondary market

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The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. The initial sale of the security by the issuer to a purchaser, who pays proceeds to the issuer, is the primary market. [1] All sales after the initial sale of the security are sales in the secondary market. [2] Whereas the term primary market refers to the market for new issues of securities, and "[a] market is primary if the proceeds of sales go to the issuer of the securities sold," the secondary market in contrast is the market created by the later trading of such securities. [3]

Contents

With primary issuances of securities or financial instruments (the primary market), often an underwriter purchases these securities directly from issuers, such as corporations issuing shares in an IPO or private placement. Then the underwriter re-sells the securities to other buyers, in what is referred to as a secondary market or aftermarket (or a buyer in contrast may buy directly from the federal government, in the case of a government issuing treasuries). [4]

Forms of secondary market

The New York Stock Exchange New York Stock Exchange Facade 2015.jpg
The New York Stock Exchange

The secondary market can be for a variety of assets, that can vary from stocks to loans, from fragmented to centralized, and from illiquid to very liquid.

The major stock exchanges are the most visible example of liquid secondary markets—in this case, for stocks of publicly traded companies. Exchanges such as the New York Stock Exchange, London Stock Exchange, and Nasdaq Stock Market provide centralized, liquid secondary markets for investors who wish to buy or sell stocks that trade on those exchanges. Most bonds and structured products trade "over the counter", or by phoning the bond desk of one’s broker-dealer. Loans sometimes trade online, using a loan exchange. [5]

Another usage of "secondary market" is to refer to loans which are sold by a mortgage bank to investors such as Fannie Mae and Freddie Mac. The term "secondary market" is also used to refer to the market for any used goods or assets, or an alternative use for an existing product or asset where the customer base is the second market (for example, corn has been traditionally used primarily for food production and feedstock, but a "second" or "third" market has developed for use in ethanol production). [6]

Function

Courtyard of the Amsterdam Stock Exchange (Beurs van Hendrick de Keyser in Dutch) by Emanuel de Witte, 1653. Emanuel de Witte - De binnenplaats van de beurs te Amsterdam.jpg
Courtyard of the Amsterdam Stock Exchange (Beurs van Hendrick de Keyser in Dutch) by Emanuel de Witte, 1653.

In the secondary market, securities are sold by and transferred from one buyer to another. It is therefore important that the secondary market be highly liquid (originally, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly; this is how stock exchanges originated (see History of the Stock Exchange). As a general rule, the greater the number of investors that participate in a given marketplace, and the greater the centralization of that marketplace, the more liquid the market.[ citation needed ]

Accurate share price allocates scarce capital more efficiently when new projects are financed through a new primary market offering, but accuracy may also matter in the secondary market because: 1) price accuracy can reduce the agency costs of management, and make hostile takeover a less risky proposition and thus move capital into the hands of better managers; and 2) accurate share price aids the efficient allocation of debt finance whether debt offerings or institutional borrowing. [7]

The term may refer to markets in things of value other than securities. For example, the ability to buy and sell intellectual property such as patents, or rights to musical compositions, is considered a secondary market because it allows the owner to freely resell property entitlements issued by the government. [8] Similarly, secondary markets can be said to exist in some real estate contexts as well (e.g., ownership shares of time-share vacation homes are bought and sold outside of the official exchange set up by the timeshare issuers). These have very similar functions as secondary stock and bond markets in allowing for speculation, providing liquidity, and financing through securitization. This facilitates liquidity and marketability of the long-term instrument. It also provides instant valuation of securities caused by changes in the environment. [9]

Private secondary markets

Private-equity secondary market refers to the buying and selling of pre-existing investor commitments to private-equity funds. Sellers of private-equity investments sell not only the investments in the fund, but also their remaining unfunded commitments to the funds. [10]

Due to the increased compliance and reporting obligations on U.S. public company boards of directors and management and public accounting firms enacted in the Sarbanes–Oxley Act of 2002, private secondary markets began to emerge, such as SecondMarket and SecondaryLink. These markets are generally only available to institutional or accredited investors, and allow trading of unregistered and private company securities.[ citation needed ]

See also

Related Research Articles

<span class="mw-page-title-main">Capital market</span> Finance

A capital market is a financial market in which long-term debt or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments. Financial regulators like Securities and Exchange Board of India (SEBI), Bank of England (BoE) and the U.S. Securities and Exchange Commission (SEC) oversee capital markets to protect investors against fraud, among other duties.

The primary market is the part of the capital market that deals with the issuance and sale of securities to purchasers directly by the issuer, with the issuer being paid the proceeds. A primary market means the market for new issues of securities, as distinguished from the secondary market, where previously issued securities are bought and sold. A market is primary if the proceeds of sales go to the issuer of the securities sold. Buyers buy securities that were not previously traded.

<span class="mw-page-title-main">Financial market</span> Generic term for all markets in which trading takes place with capital

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets as commodities.

<span class="mw-page-title-main">Security (finance)</span> Tradable financial asset

A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any form of financial instrument, even though the underlying legal and regulatory regime may not have such a broad definition. In some jurisdictions the term specifically excludes financial instruments other than equities and fixed income instruments. In some jurisdictions it includes some instruments that are close to equities and fixed income, e.g., equity warrants.

<span class="mw-page-title-main">Stock market</span> Place where stocks are traded

A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks, which represent ownership claims on businesses; these may include securities listed on a public stock exchange, as well as stock that is only traded privately, such as shares of private companies which are sold to investors through equity crowdfunding platforms. Investment is usually made with an investment strategy in mind.

In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the price at which an asset can be sold, and how quickly it can be sold. In a liquid market, the trade-off is mild: one can sell quickly without having to accept a significantly lower price. In a relatively illiquid market, an asset must be discounted in order to sell quickly. Money, or cash, is the most liquid asset because it can be exchanged for goods and services instantly at face value.

<span class="mw-page-title-main">Bond (finance)</span> Instrument of indebtedness

In finance, a bond is a type of security under which the issuer (debtor) owes the holder (creditor) a debt, and is obliged – depending on the terms – to provide cash flow to the creditor. The timing and the amount of cash flow provided varies, depending on the economic value that is emphasized upon, thus giving rise to different types of bonds. The interest is usually payable at fixed intervals: semiannual, annual, and less often at other periods. Thus, a bond is a form of loan or IOU. Bonds provide the borrower with external funds to finance long-term investments or, in the case of government bonds, to finance current expenditure.

<span class="mw-page-title-main">Warrant (finance)</span> Security that entitles the holder to buy stock

In finance, a warrant is a security that entitles the holder to buy or sell stock, typically the stock of the issuing company, at a fixed price called the exercise price.

<span class="mw-page-title-main">Day trading</span> Buying and selling financial instruments within the same trading day

Day trading is a form of speculation in securities in which a trader buys and sells a financial instrument within the same trading day, so that all positions are closed before the market closes for the trading day to avoid unmanageable risks and negative price gaps between one day's close and the next day's price at the open. Traders who trade in this capacity are generally classified as speculators. Day trading contrasts with the long-term trades underlying buy-and-hold and value investing strategies. Day trading may require fast trade execution, sometimes as fast as milli-seconds in scalping, therefore direct-access day trading software is often needed.

<span class="mw-page-title-main">Market maker</span> Stock market trading entity

A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the bid–ask spread, or turn. The benefit to the firm is that it makes money from doing so; the benefit to the market is that this helps limit price variation (volatility) by setting a limited trading price range for the assets being traded.

<span class="mw-page-title-main">Repurchase agreement</span> Form of short-term borrowing

A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two parties, buys them back shortly afterwards, usually the following day, at a slightly higher price.

An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges.

<span class="mw-page-title-main">Fixed income</span> Type of investment

Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the principal amount on maturity. Fixed-income securities — more commonly known as bonds — can be contrasted with equity securities – often referred to as stocks and shares – that create no obligation to pay dividends or any other form of income. Bonds carry a level of legal protections for investors that equity securities do not — in the event of a bankruptcy, bond holders would be repaid after liquidation of assets, whereas shareholders with stock often receive nothing.

<span class="mw-page-title-main">Securities Exchange Act of 1934</span> 1934 U.S. legislation establishing rules and regulatory bodies for financial markets

The Securities Exchange Act of 1934 is a law governing the secondary trading of securities in the United States of America. A landmark of wide-ranging legislation, the Act of '34 and related statutes form the basis of regulation of the financial markets and their participants in the United States. The 1934 Act also established the Securities and Exchange Commission (SEC), the agency primarily responsible for enforcement of United States federal securities law.

Penny stocks are common shares of small public companies that trade for less than one dollar per share. The U.S. Securities and Exchange Commission (SEC) uses the term "Penny stock" to refer to a security, a financial instrument which represents a given financial value, issued by small public companies that trade at less than $5 per share. Penny stocks are priced over-the-counter, rather than on the trading floor. The term "penny stock" refers to shares that, prior to the SEC's classification, traded for "pennies on the dollar". In 1934, when the United States government passed the Securities Exchange Act to regulate any and all transactions of securities between parties which are "not the original issuer", the SEC at the time disclosed that equity securities which trade for less than $5 per share could not be listed on any national stock exchange or index.

<span class="mw-page-title-main">Securities market</span> Component of the wider financial market

Security market is a component of the wider financial market where securities can be bought and sold between subjects of the economy, on the basis of demand and supply. Security markets encompasses stock markets, bond markets and derivatives markets where prices can be determined and participants both professional and non professional can meet.

<span class="mw-page-title-main">Bond market</span> Financial market where participants can issue new debt or buy and sell debt securities

The bond market is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. This is usually in the form of bonds, but it may include notes, bills, and so on for public and private expenditures. The bond market has largely been dominated by the United States, which accounts for about 39% of the market. As of 2021, the size of the bond market is estimated to be at $119 trillion worldwide and $46 trillion for the US market, according to the Securities Industry and Financial Markets Association (SIFMA).

An equity-linked note (ELN) is a debt instrument, usually a bond issued by a financial institution such as an investment bank or a subsidiary of a commercial bank. ELNs are liabilities of the issuer, but the final payout to the investor is based on an unrelated company's stock price, a stock index or a group of stocks or stock indices. The underlying stocks typically have large market capitalizations. Equity-linked notes are a type of structured product and are often marketed to unsophisticated retail investors.

<span class="mw-page-title-main">Stock</span> Shares into which ownership of the corporation is divided

Stocks consist of all the shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporation in proportion to the total number of shares. This typically entitles the shareholder (stockholder) to that fraction of the company's earnings, proceeds from liquidation of assets, or voting power, often dividing these up in proportion to the amount of money each stockholder has invested. Not all stock is necessarily equal, as certain classes of stock may be issued, for example, without voting rights, with enhanced voting rights, or with a certain priority to receive profits or liquidation proceeds before or after other classes of shareholders.

<span class="mw-page-title-main">Securities market participants (United States)</span>

Securities market participants in the United States include corporations and governments issuing securities, persons and corporations buying and selling a security, the broker-dealers and exchanges which facilitate such trading, banks which safe keep assets, and regulators who monitor the markets' activities. Investors buy and sell through broker-dealers and have their assets retained by either their executing broker-dealer, a custodian bank or a prime broker. These transactions take place in the environment of equity and equity options exchanges, regulated by the U.S. Securities and Exchange Commission (SEC), or derivative exchanges, regulated by the Commodity Futures Trading Commission (CFTC). For transactions involving stocks and bonds, transfer agents assure that the ownership in each transaction is properly assigned to and held on behalf of each investor.

References

  1. "Primary Market". U.S. Securities and Exchange Commission.
  2. "What is secondary market? Definition and Types of Bonds".
  3. "Section 7.03.120 - Definitions; Primary Market" (PDF).
  4. "Secondary Market". Investopedia. March 30, 2022.
  5. Manjula A. Soudatti (2021). Investment Management
  6. Raghu Korrapati (2014). Validated Management Practices
  7. Artyom Durnev et al. (2003). "Law, Share Price Accuracy and Economic Performance: The New Evidence", 102 MICH. L. REV. 331.
  8. Robert P. Merges (May 17, 2012). "Secondary Patent Markets: A Possible Role for Startups". The Media Institute.
  9. Bharati V. Pathak (2011). The Indian Financial System; Markets, Institutions and Services.
  10. Ryan Cotton (2012). "The Benefits of Secondary Funds in a Private Equity Portfolio."