What is Function of Secondary Market?

A secondary market is a marketplace where securities, such as stocks and bonds, are bought and sold among investors after their initial issuance in the primary market.

Unlike primary markets, where securities are issued directly by companies or governments to raise capital (either via an IPO or any other source), secondary markets facilitate the trading of existing securities.

Secondary markets provide a platform for investors to enter and exit positions without affecting the issuing entity.

The Bombay Stock Exchange (BSE), National Stock Exchange (NSE) as well as all other stock exchanges as well as the bond markets, are secondary markets.

The Vital Functions of Secondary Markets...

1. Liquidity Provision: One of the primary functions of secondary markets is to provide liquidity to investors. This means that investors can quickly buy or sell securities without causing significant price changes, ensuring that assets can be easily converted into cash. This liquidity is crucial for investors... the same type of liquidity is not available in the unlisted markets though.
2. Price Discovery: Secondary markets play a crucial role in determining the fair market value of securities through the forces of supply and demand. The continuous trading of securities allows for the establishment of market prices, which reflect the collective sentiment of investors regarding the value of the assets. This price discovery mechanism is essential for efficient capital allocation and investment decision-making.
3. Market Efficiency: The efficient functioning of secondary markets contributes to overall market efficiency. The constant flow of information and the rapid adjustment of prices to new data ensure that securities are priced accurately, reflecting all available information.
4. Capital Formation: While primary markets are directly responsible for capital formation, secondary markets indirectly support this process by providing liquidity and price stability.
5. Economic Indicators: Secondary markets serve as barometers of the economy, with indices like the Sensex or the Nifty reflecting the overall health of the Indian financial market and, by extension, the Indian economy. Movements in these indices can signal investor sentiment and economic trends, providing valuable insights for policymakers and market participants.

Examples of Secondary Market

#1 Stock Exchanges

Stock exchanges are centralised platforms where trading take place between the buyer and the seller. Bombay Stock Exchange (BSE), National Stock Exchange (NSE), and New York Stock Exchange (NYSE) are examples of such platforms.

Here, the exchange is responsible for being the intermediary that connects buyers and sellers. As a result, counterparty risk is almost zero as the exchange is a guarantor.

#2 Over the Counter Market

Over the counter (OTC) market refers to the process where securities are traded in an informal way. OTC market is a decentralised market, comprising participants engaging in trading among themselves.

OTC market includes the securities that didn't fulfill the requirements to have a listing on the stock exchanges. It is a bilateral contract where two parties are involved i.e. the investor and dealer.

Stocks traded in OTC market are basically of smaller companies that cannot meet exchange requirements for formal exchange.

Here, the risk becomes higher in the absence of regulatory oversight. The price of securities may also differ from one seller to another as there is intense competition in acquiring higher volume.

Foreign exchange market (FOREX) is an example of an over-the-counter market.

Apart from the stock exchanges and OTC market, other types of secondary market include auction market and dealer market.

#3 Auction Market

Auction market is a platform for buyers and sellers to arrive at an understanding of the rate at which the securities are to be traded. The information related to pricing is put out in the public domain, including the bidding price of the offer.

#4 Dealer Market

Dealer market is another type of secondary market in which various dealers indicate prices of specific securities for a transaction. Foreign exchange trade and bonds are traded primarily in a dealer market.

In Conclusion

The functions of secondary market are multifaceted.

In short, primary markets are new markets, and secondary markets are resale markets. Understanding how these markets function gives investors better awareness on where to find which security.

Both the financial markets play a major role in the mobilisation of funds for companies that help move the wheels of the economy.

The stock market affects individual businesses in an economy in many different ways.

This is because an economy and its stock market are basically aligned. When the stock market is performing well, it is usually a function of a growing economy.

When the economy is growing, individual businesses produce more and usually expand.

In a market economy, the role of the capital market is of utmost importance.

A well-functioning capital market is vital in a modern economy to be perform an efficient transfer of resources from those who save towards those who need capital.

For more on secondary markets, check out these articles which will act as a guidepost for beginners.

• How to Invest in the Share Market
• How to Play the Stock Market

Also check out this section which provides colossal wealth of information of the listed companies in India.