Secondary Market

Article byWallstreetmojo Team
Edited byAlfina
Reviewed byDheeraj Vaidya, CFA, FRM

Secondary Market Meaning

A secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.

Secondary Market

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The secondary market is the opposite of the primary marketPrimary MarketThe primary market is where debt-based, equity-based or any other asset-based securities are created, underwritten and sold off to investors. It is a part of the capital market where new securities are created and directly purchased by the issuer.read more where these securities originate. In a primary market, the companies issue securities via Initial Public Offerings (IPO) and allow investors to buy them for the first time. The National Stock Exchange (NSE), the New York Stock Exchange (NYSE), London Stock Exchange (LSE), and the NASDAQ are a few secondary market examples.

Key Takeaways

  • A secondary market is any market the securities, assets, or products enter after their first-time sale/ purchase. It is carried out in a primary market between the original issuer and buyer/seller.
  • Also known as aftermarkets, these offer better growth opportunities to investors, enhancing the economic condition of any nation.
  • Fixed income, variable income, and hybrid instruments are categories in which the investment vehicles of aftermarket are classified.
  • Some of the types of aftermarkets are – Stock Exchanges, Over-the-Counter (OTC), auction, and dealer markets.

How Secondary Market Works?

A secondary market is a marketplace where investors buy stocks, bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, and other securities already traded earlier. For the original issuing company, it is the market it can monitor and control the transactions, helping the management make well-informed decisions.

When securities are traded on this platform, the original issuers do not intervene in trading the securities. Even the prices of the assets are determined based on how they perform in the market and not influenced by the issuing company’s name in any manner.

As soon as a stock or any security reaches the marketplace after its first-time purchase or sale, it is said to have entered the aftermarket. Such markets have high liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more, and investors can buy or sell stocks easily for cash. The trades occurring in the aftermarket indicate how well a nation’s economic condition is. If the stock prices are up, it shows a booming economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. On the contrary, if the prices go down, it marks a deteriorating economy.

A non-primary market offers big and small investors an equal chance, helping them trade in their desired stocks. It marks economic efficiencyEconomic EfficiencyEconomic efficiency in microeconomics refers to the state that manifests optimum resource allocation, the minimum cost for producing goods and services, and maximum outcome.read more as sellers and buyers value the security traded more than its prices. Moreover, when an investor enters the aftermarket, there is always an assurance of having authorized securities available for trade. 

Before the stock exchangesStock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more list the assets, they undergo verification and valuation assessment. In addition, they ensure the company stocks and the entire trading activity remains well-regulated and compliant as per financial reportingFinancial ReportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more standards. As a result, investors know they trust the right stocks for trading.

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Secondary Market Instruments

The instruments available in the aftermarket to trade in are broadly classified into three categories:

Secondary Market instruments

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#1 – Fixed Income Instrument

As the name implies, these instruments form part of investments that guarantee fixed incomeFixed IncomeFixed Income refers to those investments that pay fixed interests and dividends to the investors until maturity. Government and corporate bonds are examples of fixed income investments.read more in the form of regular payments. For example, the interest paid monthly and the principal amount on maturity fall under this category. Some of the other examples include debenturesDebenturesDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. In return, investors are compensated with an interest income for being a creditor to the issuer.read more, bonds, etc.

#2 – Variable Income Instrument

Investments made in these instruments do not guarantee a fixed, regular income. Instead, the returns vary based on the market fluctuations. The investment made, in this case, involves high risk and, at the same time, it can be highly rewarding. Based on the risk and reward factors, the returns are generated. Some of the examples of variable income instruments include equity Equity Equity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet.read moreand derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. read more

#3 – Hybrid Instrument

A few secondary market instruments offer both fixed and variable returns on investments. For example, a convertible debenture acts as primary debt security and could be converted into equity shares after a set period. 

Types

An aftermarket is segregated into different segments, but the most widely accepted classifications are as follows:

Secondary Market Types

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#1 – Stock Exchanges

A stock exchange is a centralized platform where trading occurs. Investors can buy or sell stocks without having to know each other personally. The only thing that matters is whether the prices suit buyers to purchase and sellers to sell the stocks. The exchanges work under strict regulation and only list stocks or assets for trade when fully verified. Thus, investing in securities via exchanges is the safest and most trustworthy option for small and big investors.

The stock exchange services can be enjoyed for commission and exchange charges. Some well-known stock exchanges are the National Stock Exchange (NSE), the New York Stock Exchange (NYSE), the NASDAQ, etc.

#2 – Over-the-Counter (OTC) Markets

An OTC marketOTC MarketOTC markets are the markets where trading of financial securities such as commodities, currencies, stocks, and other non-financial trading instruments takes place over the counter (instead of a recognized stock exchange), directly between the two parties involved, with or without the help of private securities dealers.read more allows individual participants to deal with each other. However, this decentralized platform is where investors remain at a higher risk due to the lack of regulatory mechanisms. With increased competition, every individual or entity tries to invest and grab a high volume of stocks to trade in the future. As a result, the securities prices may vary from one participant to another.

FOREX is an example of an OTC market.

Besides the above two types, a few more are less popular. These include dealer market Dealer Market A dealer market is where dealers engage in buying and selling a specific financial instrument using their account electronically without a third party and make the market by quoting the offer price and bid price.read moreand auction marketAuction MarketAuction Market is a marketplace where the buyers and sellers trade stock by bidding. The price is calculated based on the highest amount a buyer is ready to pay and the lowest amount a seller is ready to accept. read more. In a dealer market, dealers fix a trade price, while in an auction market, the buyers and sellers can negotiate and take a trade forward accordingly.

Examples of Secondary Market

Let us understand the concept better with the following secondary market examples:

Example #1

Stephen buys the stocks of Company A, the original issuer, of the securities. Then, he plans to sell the same set of stocks to other investors. Thus, the seller decides to list them in a stock exchange. Mathew finds those sets of shares at a reasonable price, and he books them. In this scenario, when Stephen buys from Company A, the transaction is done the first time for those sets of stocks. Thus, it is a primary market transaction. Further, when Stephen sells the same stocks to Mathew, the trade occurs in an aftermarket.

Example #2

Some assets or products are bought and sold both in a primary market and aftermarket. For example, in one of its articles, Forbes indicated how buying and selling wine could be a fruitful investment for financial participants in both these types of markets. When producers sell wine to consumers via wholesale distributors, the trade occurs in a primary market. On the contrary, the transaction occurs in the aftermarket retailers, and buyers collect the same wine through auction houses, exchanges, and wine brokers. 

Secondary Market vs Primary Market

Investors tend to confuse a lot between secondary market and primary market. However, it is easy to differentiate between them if the basics are clear. When they buy or sell securities the first time, i.e., directly from an original issuer, the transaction or dealing occurs in a primary market. On the other hand, the trade happens in an aftermarket when they purchase or sell the securities the next time. 

Let us understand the concept with a simple example of how the secondary market for mortgages works:

The new homes introduced in the market for sale for the first time represent a primary market. However, when buyers buy those homes and furnish them properly for the next sale to earn more, the houses enter an aftermarket. In the latter case, homebuyers would no more be the primary buyer. Instead, they buy those homes after the original owners have already sold them to the next seller.

Frequently Asked Questions (FAQs)

What is a secondary market?

It is a marketplace where financial participants buy or sell securities, which have already been purchased or sold primarily by the original issuers. These original issuers can be a company, government entity, corporation, bank, etc. The aftermarket helps determine the economic situation of a nation as per the rise and fall in the securities prices. If there is a rise, it indicates progress, while if there is a fall, it marks depreciation.

What are the advantages and disadvantages of a secondary market?

The pros and cons of aftermarket are as follows:

advantages and disadvantages of a secondary market

Why are secondary markets important?

An aftermarket is important because of the following reasons:

• A great exit route for IPO investors
• Freedom to buy/sell securities
• Opportunity to buy or sell further
• Helps in economic growth
• Companies can monitor and control trading unlisted or non-verified stocks/securities

This article is a guide to Secondary Market & its Meaning. Here we explain how it works along with its instruments, types, and examples. You can also go through our recommended articles on corporate finance –