Secondary markets, referred to also as aftermarkets or follow-on public offerings, refer to the market in which previously issued financial instruments, such as stocks, bonds, options and futures, are traded.
What is a Secondary Market?
Securities that investors already own are bought and sold in the secondary market. Although stocks are also sold on the primary market when they are first issued, it is what most people think of as “the stock market.” These exchanges, such as the NASDAQ and the New York Stock Exchange (NYSE), are secondary markets.
Meaning of Secondary Market
Other types of secondary markets exist in addition to stocks, which are one of the most commonly traded securities. Mutual funds and bonds are bought and sold on secondary markets by investment banks, corporations and individuals. Secondary market mortgages are also purchased by Fannie Mae and Freddie Mac.
Those transactions that take place on the secondary market are termed secondary because they are one step removed from the initial transaction that created the securities in question. An institution may create mortgage security by writing a mortgage for a consumer. On the secondary market, the bank can sell the property to Fannie Mae.
Example of Secondary Market Transactions
All types of investors can benefit from secondary market transactions. Their costs are significantly reduced because of high volume transactions. The following are a few examples of secondary market transactions involving securities.
Securities are traded on a secondary market between investors, not with the issuer. Investors who wish to purchase Larsen & Toubro stock will have to do so from another investor who owns such shares, not directly from L&T. Therefore, the company will not be involved in the transaction.
In a secondary market, individual and corporate investors, as well as investment banks, buy and sell bonds and mutual funds.
Types of Secondary Market
There are two types of secondary markets – stock exchanges and over-the-counter markets. Exchanges are centralised platforms where securities are traded without any contact between buyers and sellers. Examples of such platforms include the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).
One will not find direct contact between the seller and the buyer of securities in this type of secondary market. Regulations are in place to ensure the safety of trading. In this case, the exchange is a guarantor, so there is almost no counterparty risk. Exchanges have a relatively high transaction cost because of exchange fees and commissions.
Over the Counter Markets
Investors trade among themselves on these decentralised markets. In such markets, there is fierce competition to get higher volumes, which leads to price differences between sellers. Due to the one-to-one nature of the transaction, the risk is higher than with exchanges. Examples of OTC markets include a foreign exchange.
How does the Secondary Market work?
Rather than trading directly with an issuer, investors trade in secondary markets. When you trade on a secondary market, the transaction occurs after the asset has already been issued on a primary market.
The mortgage market is a good example to use when discussing the secondary market, as it is another security that is commonly traded on the secondary market.
Financial institutions write mortgages for consumers, which is a form of mortgage security. A second transaction can be created when the bank sells the loan to Fannie Mae or Freddie Mac to finance the construction and sale of housing on the secondary market.