Secondary Market Meaning, Role, Function, Structure, Players

02/07/2022 1 By indiafreenotes

The secondary market is where securities are traded after the company has sold its offering on the primary market. It is also referred to as the stock market. The New York Stock Exchange (NYSE), London Stock Exchange, and Nasdaq are secondary markets.

The Secondary Market refers to the financial marketplace where existing securities, previously issued in the primary market, are bought and sold among investors. It provides a platform for individuals and institutions to trade stocks, bonds, and other financial instruments after their initial issuance. Unlike the primary market, which involves the issuance of new securities, the secondary market facilitates the resale and exchange of already-existing securities. Stock exchanges, such as the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) in India, are key components of the secondary market, providing the infrastructure for transparent and organized trading activities. The secondary market enhances liquidity, price discovery, and market efficiency.

Small investors have a much better chance of trading securities on the secondary market since they are excluded from IPOs. Anyone can purchase securities on the secondary market as long as they are willing to pay the asking price per share.

A broker typically purchases the securities on behalf of an investor in the secondary market. Unlike the primary market, where prices are set before an IPO takes place, prices on the secondary market fluctuate with demand. Investors will also have to pay a commission to the broker for carrying out the trade.

The volume of securities traded varies from day to day, as supply and demand for the security fluctuates. This also has a big effect on the security’s price.

Because the initial offering is complete, the issuing company is no longer a party to any sale between two investors, except in the case of a company stock buyback. For example, after Apple’s Dec. 12, 1980, IPO on the primary market, individual investors have been able to purchase Apple stock on the secondary market. Because Apple is no longer involved in the issue of its stock, investors will, essentially, deal with one another when they trade shares in the company.

Role of Secondary Market

  • Maintaining the Fair Price of Shares

The secondary market is a market of already issued securities after the initial public offering (IPO). Capital markets run on the basis of supply and demand of shares. Secondary markets maintain the fair price of shares depending on the balance of demand and supply. As no single agent can influence the share price, the secondary markets help keep the fair prices of securities intact.

  • Facilitating Capital Allocation

Secondary markets facilitate capital allocation by price signaling for the primary market. By signaling the prices of shares yet to be released in the secondary market, the secondary markets help in allocating shares.

  • Offering Liquidity and Marketability

Second-hand shares are of no use if they cannot be sold and bought for liquid cash whenever needed. The shareholders usually use the share markets as the place where there is enough liquidity and marketability of shares. That means that the secondary markets play the role of a third party in the exchange of shares.

Without a secondary market, the buyers and sellers would be left with a self-exchange in one-to-one mode that is not quite effective till now. Therefore, the secondary market is a facilitating body of liquidity and marketability for the shareholders.

  • Adjusting the Portfolios

Secondary markets allow investors to adapt to adjusting portfolios of securities. That is, the secondary markets allow investors to choose shares for buying as well as for selling to build a solid portfolio of shares that offers maximum returns. Investors and shareholders can change their investment portfolios in secondary markets that cannot be done anywhere else.

Functions of Stock Market

  1. Capital Formation:

Primary Market: The stock market facilitates the primary market, where companies raise capital by issuing new securities, such as stocks and bonds. This process allows businesses to fund expansion, research, and other capital-intensive activities.

  1. Secondary Market Trading:

Liquidity Provision: The secondary market provides a platform for investors to buy and sell existing securities, enhancing liquidity. Investors can easily convert their investments into cash, and this liquidity contributes to market efficiency.

  1. Price Discovery:

Market Valuation: The stock market plays a crucial role in determining the fair market value of securities through the continuous buying and selling of shares. This price discovery process reflects investor perceptions of a company’s performance and future prospects.

  1. Facilitation of Investment:

The stock market encourages savings and investment by providing individuals and institutions with opportunities to invest in a diversified portfolio of securities. This helps channel funds from savers to productive enterprises.

  1. Ownership Transfer:

Investors can easily buy and sell securities, allowing for the transfer of ownership in a transparent and regulated manner. This facilitates the transfer of funds between investors and supports portfolio diversification.

  1. Borrowing and Lending:

The stock market serves as a platform for companies to raise funds by issuing bonds. Investors who purchase these bonds essentially lend money to the issuing companies, creating an additional avenue for corporate financing.

  1. Market Indicators:

The performance of stock indices, such as the Nifty 50 and the Sensex in India, serves as indicators of the overall health and sentiment of the financial markets and the economy at large.

  1. Corporate Governance:

Stock markets impose certain listing requirements on companies, promoting transparency and adherence to corporate governance standards. Companies with publicly traded shares are often subject to higher scrutiny, enhancing investor confidence.

  1. Dividend Distribution:

Companies listed on stock exchanges can distribute dividends to their shareholders, providing a return on investment. Dividends are a key factor influencing investment decisions and shareholder wealth.

10. Risk Mitigation:

Investors can manage risk through diversification, buying and selling securities, and utilizing various financial instruments available in the stock market, such as options and futures.

11. Economic Indicator:

The stock market’s performance is often considered a barometer of economic health. Bullish markets are associated with economic optimism, while bearish markets may reflect concerns about economic conditions.

12. Market Efficiency:

The stock market allocates resources efficiently by directing capital to companies with the most promising growth prospects. Efficient market mechanisms contribute to the optimal allocation of resources within the economy.

13. Facilitation of Mergers and Acquisitions:

The stock market plays a role in corporate restructuring by facilitating mergers and acquisitions. Companies can use their shares for acquisitions, enabling strategic growth and consolidation.

Structure of Stock Market

The stock market in India has a well-defined structure, comprising various entities and mechanisms that facilitate the buying and selling of securities. The structure encompasses both primary and secondary markets, each serving distinct functions in the capital market ecosystem.

  1. Primary Market:

The primary market is where new securities are issued and initially offered to the public. It consists of the following elements:

    • Issuer: The company or entity that issues new securities to raise capital. This can include initial public offerings (IPOs) and additional offerings.
    • Underwriter: Investment banks or financial institutions that facilitate the issuance by committing to purchase the entire issue and then selling it to the public.
    • Registrar and Transfer Agent (RTA): Entities responsible for maintaining records of shareholders and processing share transfers.
  1. Secondary Market:

The secondary market is where existing securities are traded among investors. The primary components include:

    • Stock Exchanges: Platforms where buyers and sellers come together to trade securities. In India, the two primary stock exchanges are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). They regulate and oversee the trading activities and ensure market integrity.
    • Brokers and Sub-Brokers: Intermediaries authorized to facilitate securities transactions on behalf of investors. They act as a link between investors and the stock exchanges.
    • Depositories: Entities that hold and maintain securities in electronic form. In India, the two central depositories are the National Securities Depository Limited (NSDL) and the Central Depository Services Limited (CDSL). They facilitate the electronic transfer of securities.
    • Clearing Corporation: Entities that handle the clearing and settlement of trades, ensuring the smooth and secure transfer of securities and funds between buyers and sellers. In India, the National Securities Clearing Corporation Limited (NSCCL) and the Clearing Corporation of India Limited (CCIL) play crucial roles.
    • Custodians: Institutions responsible for safeguarding and holding securities on behalf of investors. They provide custodial services to institutional investors, foreign institutional investors (FIIs), and high-net-worth individuals.

3. Regulatory Authorities:

Regulatory bodies oversee and regulate the functioning of the stock market to ensure fair practices, investor protection, and market integrity. In India, the Securities and Exchange Board of India (SEBI) is the primary regulatory authority governing the securities market.

  1. Investors:

Investors are individuals, institutions, or entities that participate in the stock market by buying and selling securities. They can include retail investors, institutional investors, foreign investors, and other market participants.

  1. Market Intermediaries:

Various intermediaries facilitate different functions in the stock market. These include investment advisors, merchant bankers, credit rating agencies, and financial institutions that contribute to the smooth operation of the market.

  1. Indices:

Stock market indices provide a benchmark for measuring the performance of the overall market or specific segments. In India, prominent indices include the Nifty 50 and the Sensex.

  1. Market Surveillance and Compliance:

Surveillance mechanisms and compliance functions ensure that the market operates within regulatory frameworks. This includes monitoring for market abuse, insider trading, and other malpractices.

  1. Technology Infrastructure:

The stock market relies on advanced technological infrastructure to facilitate trading, clearing, and settlement processes. Electronic trading platforms, data dissemination systems, and secure networks contribute to the efficiency of market operations.

Players in Stock Market

The stock market involves various players, each playing a distinct role in the buying, selling, and overall functioning of the financial markets. These participants contribute to the liquidity, transparency, and efficiency of the stock market.

  1. Investors:

    • Retail Investors: Individual investors who buy and sell securities for personal investment. They include small-scale investors, often trading through brokerage accounts.
    • Institutional Investors: Large entities like mutual funds, pension funds, insurance companies, and hedge funds that invest on behalf of a group of individuals or their members.
  2. Stock Exchanges:

    • Bombay Stock Exchange (BSE): One of the major stock exchanges in India.
    • National Stock Exchange (NSE): Another significant stock exchange, known for electronic trading and providing a platform for various financial instruments.
  3. Brokers and Sub-Brokers:

    • Brokers: Facilitate securities transactions between buyers and sellers. They may be full-service brokers providing a range of services or discount brokers offering lower-cost trading.
    • Sub-Brokers: Individuals or entities affiliated with brokers, authorized to facilitate trades on their behalf.
  4. Market Intermediaries:

    • Merchant Bankers: Facilitate the issuance of new securities in the primary market and provide financial advisory services.
    • Underwriters: Guarantee the sale of newly issued securities, ensuring that the issuing company receives the intended capital.
  5. Depositories:

    • National Securities Depository Limited (NSDL): A central securities depository in India, holding securities in electronic form.
    • Central Depository Services Limited (CDSL): Another central depository facilitating the electronic holding and transfer of securities.
  6. Clearing Corporations:

    • National Securities Clearing Corporation Limited (NSCCL): Handles clearing and settlement for equity and derivatives segments.
    • Clearing Corporation of India Limited (CCIL): Manages clearing and settlement for fixed income and money market instruments.
  7. Regulatory Authorities:

    • Securities and Exchange Board of India (SEBI): The regulatory body overseeing the securities market in India, responsible for investor protection and market integrity.
  8. Corporate Entities:

    • Listed Companies: Companies whose shares are listed on stock exchanges, allowing them to raise capital and provide ownership to shareholders.
    • Unlisted Companies: Companies that are not listed on stock exchanges.
  9. Research Analysts and Advisory Firms:

Professionals and firms providing research, analysis, and investment advice to investors. They play a role in guiding investment decisions.

10. Credit Rating Agencies:

Entities that assess the creditworthiness of issuers and their securities, providing credit ratings to assist investors in evaluating risk.

11. Custodians:

Financial institutions responsible for the safekeeping of securities on behalf of investors, particularly institutional investors.

12. Government:

The government, through various agencies, can influence the stock market through fiscal and monetary policies, regulations, and initiatives.

13. Media:

Financial news outlets and media play a role in disseminating information about market trends, company performance, and economic developments, influencing investor sentiment.

14. Arbitrageurs and Speculators:

Individuals or entities engaging in arbitrage (exploiting price differences) and speculation (betting on future price movements) to profit from market inefficiencies.

15. Technology Providers:

Companies providing technology infrastructure, trading platforms, and data services essential for the operation of electronic trading in the modern stock market.