Secondary Market Meaning, Nature, Functions, Intermediaries

Table of Contents:

  • Meaning of Secondary Market
  • Nature of Secondary Market
  • Functions of Secondary Market
  • Intermediaries in Secondary Market

Meaning of Secondary Market

The secondary market is also referred to as the aftermarket. It is the financial market where previously issued securities and financial instruments such as bonds, stocks, and futures are bought and sold. The term “secondary market” is also employed to describe the market for used goods or assets, or an alternative use for an existing product or asset wherein the customer base constitutes the second market. For example, corn has traditionally been used primarily for food production and as feedstock, but a second or even third market has emerged for its use in ethanol production. It is also known as the Stock Exchange or Stock Market.

In the secondary markets, existing securities are sold and bought among investors or traders, usually on an organised securities exchange and over-the-counter, or elsewhere.

In primary issuances of securities or financial instruments, also known as the primary market, investors acquire these securities directly from issuers. This could involve corporations issuing shares in an IPO or private placement, or direct acquisition from the federal government in the case of treasuries. Following the initial issuance, investors have the option to buy from other investors in the secondary market.

The stocks are listed and traded on stock exchanges which are entities (a corporation or mutual organizations) specialized in the business of bringing buyers and sellers of stocks and securities together. Stock exchanges are organized and regulated markets for various securities issued by the corporate sector and other institutions. Stock exchanges facilitate the unrestricted buying and selling of securities, just as commodity exchanges enable the trading of commodities.

Definitions of Secondary Market

According to Pyle, “Security exchanges are marketplaces where securities that have been listed thereon may be bought and sold for either investment or speculation”. Stock exchanges allow trading in securities for both genuine investors and speculators.

As per the Securities Contract (Regulation) Act, 1956, “Stock exchange means anybody or individuals whether incorporated or not, constituted to assist, regulate or controlling the business of buying, selling in securities”.

According to Husband and Dockeray, “Securities or stock exchanges are privately organized markets which are used to facilitate trading in securities”.

Nature of Secondary Market

The nature of secondary market is as follows:

1) This market is not the place of the origin of the security.

2) Securities are sold by the existing investors to other investors.

3) Stock exchange deals in previously issued securities.

4) Securities are not directly issued by the company to investors.

5) Stock exchanges do not directly contribute to capital formation.

6) Stock exchange merely transfers existing securities between buyers and sellers.

7) The intending buyer and seller can buy and sell securities through brokers.

8) Stock exchange provides liquidity to the investment and enhances the marketability of securities.

Functions of Secondary Market

The functions of secondary market are as follows:

1) Continuous Market for Securities

Stock exchanges offer a ready market for securities. Once listed, these securities continue to be traded on the exchanges, regardless of changes in ownership. The exchanges provide a consistent platform for the trading of securities.

2) Ensure Liquidity of Capital

Stock exchanges offer a platform where shares and stocks can be readily converted into cash. These exchanges provide a ready market where buyers and sellers are consistently available, allowing those in need of immediate cash to sell their holdings. Without this option, many individuals might have been hesitant to tie up their savings in securities, as the ability to convert them back into cash would have been uncertain.

3) Mobilizing Surplus Savings

Stock exchanges offer a ready market for various securities, allowing investors to easily invest their savings by purchasing shares, bonds, etc., from the exchanges. Without this facility, many individuals seeking investment opportunities for their savings would face limited avenues. In this manner, stock exchanges play a crucial role in absorbing the surplus funds of investors.

4) Evaluation of Securities

Investors can assess the value of their holdings by examining the prices quoted for those securities on different exchanges. The securities are quoted within the open dynamics of demand and supply, and the prices are determined by the free market. Stock exchanges facilitate the evaluation of any type of security listed on them.

5) Safety in Dealings

The transactions at stock exchanges are governed by the well-defined rules and regulations of the Securities Contract (Regulation) Act of 1956. There is no room for manipulating transactions, as each contract is executed according to the prescribed procedures, instilling confidence in the minds of the contracting parties.

6) Helpful in Raising New Capital

New and existing businesses require capital for their operations. New businesses raise capital for the first time while existing businesses raise their capital for expansion and diversification.

7) Platform for Public Debt

The growing role of the government in economic development has necessitated the raising of substantial funds for this purpose. Stock exchanges serve as a platform for raising public debts and organized markets for government securities. Although there is no provision for a separate counter for government securities, they are traded through brokers specializing in these securities.

8) Clearing House of Business Information

Companies listing securities with exchanges must provide financial statements, annual reports, and other documents to ensure maximum publicity of corporate operations and activities. The economic and other information available at stock exchanges assists companies in formulating their policies.

9) Listing of Securities

Only listed securities can be purchased on stock exchanges. Any company wishing to list its securities must apply to the exchange authorities. Listing is permitted only after a thorough examination of the company’s capital structure, management, and prospects.

Intermediaries in Secondary Market

Major intermediaries in secondary market can be explained as follows:

1) Stock Broker

A stock broker or stockbroker is a qualified and regulated professional who buys and sells (trades) shares (in other words, stocks) and other securities through market makers on behalf of investors. These brokers also give knowledge guidance to their high-net-worth individuals, and clients, for managing their finances well and investing in portfolios for considerable wealth creation. Stock brokers can be of different types like commission brokers, jobbers, floor brokers, taraniwalla, odd lot dealers, budliwalla, arbitrageurs, security dealers, etc.

2) Individual Investors

Individual investors make implicit forecasts or assumptions about these factors without elaborate reports because they do not need to communicate beyond the purchase or sale order to their brokers. The individual does not need to prepare any formal studies because a simple one-line note may suffice to preserve the basis of a decision for future reference.

3) Financial Intermediaries

Financial intermediaries, as players in the secondary market, include various organizations that intermediate and facilitate financial transactions for both individuals and corporate customers. Thus, it refers to all kinds of financial institutions and investing institutions which facilitate financial transactions in financial markets.

Financial intermediaries accept funds from one entity and lend them to another entity. It is an intermediate between the not savers and the net borrowers of funds in an economy. They borrow from the net savers and on-lend the funds borrowed to the net borrowers.

Various financial intermediaries assist in pooling funds from savers and providing them to borrowers. They are as follows:

i) Developmental Financial Institutions

The need for the development of Financial Institutions in India was felt very strongly immediately after India attained independence. The country needed a strong capital goods sector to accelerate and support the speed of industrialization. The existing industries required long-term funds for their reconstruction, modernization, expansion and diversification programs while the new industries required enormous investment for setting up gigantic projects in the capital goods sector. However, there were gaps in the banking system and capital market which needed to be filled to meet this enormous requirement of funds.

ii) Mutual Fund

A mutual fund is a professionally managed form of collective investment that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. In a mutual fund, the fund manager, also known as the portfolio manager, trades the fund’s underlying securities, realizes capital gains or losses, and collects the dividend or interest income.

iii) Commercial Banks

Commercial banks are financial institutions that perform a wide range of banking functions, including accepting deposits, advancing loans, engaging in credit creation, and executing agency functions. They are also called joint stock banks because they are organized in the same manner as joint stock companies. They generally provide short-term loans to customers.

iv) Non-Banking Financial Institutions

The financial institutions which provide various banking facilities but are not termed as banks because they do not hold a banking license are known as Non-Banking Financial Institutions. It is a company registered under the Companies Act of 1956. Non-banking finance companies are governed by the directions issued by the Reserve Bank of India. Non-banking finance companies mainly consist of finance companies engaging in hire purchase finance, housing finance, investment, loans, equipment leasing, or mutual benefit financial activities. However, they do not include insurance companies, stock exchanges, or stock-broking companies.

v) Insurance Company

Insurance can be described as a social device designed to reduce or eliminate the risk of loss of life and property. Insurance is a collective bearing of risk. Insurance spreads the risks and losses of a few people among a large number of people as people prefer small fixed liabilities instead of big uncertain and changing liabilities. Insurance is a system of economic cooperation in which members of the community share unavoidable risks.

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