What is the Secondary Market? Its Features and Instruments
What is the Secondary Market? – The secondary market, also called the aftermarket, is a financial space where investors trade securities that were issued in the past, like stocks, bonds, options, and futures contracts. Instead of the issuing company selling these securities directly, they are now traded between investors.
The secondary market is crucial for investors as it provides liquidity. This means investors can easily and quickly sell their securities when they need cash. Moreover, investors can also buy securities to diversify their portfolio, adjust their investment mix, or protect against market risks.
There are two main types of secondary markets: exchange-traded markets and over-the-counter markets. Exchange-traded markets, like the New York Stock Exchange (NYSE) and Nasdaq, have centralized trading places, whereas over-the-counter markets, like the bond market, have decentralized trading locations.
Understanding the Secondary Market
The secondary market is an essential part of the global financial system. Here, investors can trade previously issued securities like stocks, bonds, options, and futures contracts. This market is crucial for providing liquidity and ensuring that securities are priced fairly, offering investors a just return on their investments.
In the secondary market, securities are bought and sold based on supply and demand. If a security is in high demand, its price goes up; if demand is low, its price goes down. This pricing mechanism helps ensure fair value for investments and efficient market pricing.
One significant advantage of the secondary market is liquidity, allowing investors to easily and quickly buy or sell securities. This flexibility is beneficial for investors who need to raise cash swiftly or make adjustments to their investment portfolios.
However, investing in the secondary market comes with risks. Securities prices can be volatile, and investors may not always sell at their desired prices. Additionally, there is a risk of fraud, as some securities may be falsely marketed or misrepresented to investors.
Secondary Market Instruments
Equity: Equity represents ownership in a business. When you invest in a company’s equity, you become a part-owner of that business.
Equity Shares: These are ordinary shares that signify fractional ownership in a company. Holding equity shares grants you voting rights in the company.
Right Issues: This involves issuing new shares to existing shareholders in proportion to their current holdings.
Bonus Shares: Investors receive additional shares at no extra cost, based on their existing shareholdings.
Preference Shares: Owners of preference shares are entitled to a fixed dividend, and they are paid before dividends go to ordinary equity shareholders.
Security Receipts: Issued by asset reconstruction companies (ARCs) or securitization companies to qualified institutional investors, providing a right or interest in the issued financial asset in securitization.
Government Securities (G-Secs): These securities, also known as G-Secs, come with a sovereign guarantee. Issued by the RBI on behalf of the government, G-Secs offer fixed coupon/interest rates and are paid half-yearly, with maturities ranging from 1 to 20 years.
Debentures: Debentures are bonds issued by companies with a fixed rate of interest, paid half-yearly on specific dates. The principal is repaid upon maturity, and debentures are secured against the company’s assets for debenture holders.
Bonds: Issued by companies, government agencies, and municipal bodies, bonds involve investors lending money to the issuer (company), with a promise to repay the amount on a fixed maturity date.
Features of the Secondary Market
Buyback of Shares
A buyback allows a company to invest in its own shares, reducing the number of outstanding shares in the market and increasing the share prices of the company. Notable examples of buybacks include:
TCS conducted a Rs 16,000 Crore buyback.
L&T opted for a Rs 9,000 Crore buyback at Rs 1500 per share.
Kaveri Seeds went for a Rs 200 Crore buyback.
HCL Technologies chose a Rs 4,000 Crore buyback.
Reasons for a Company Opting for a Buyback
- Increases promoter holdings.
- Raises EPS (Earnings per Share).
- Writes off capital not represented by assets, rationalizing the capital structure (debt: asset ratio is part of the capital structure).
- Aims to increase share prices.
- Utilizes surplus cash not required by the business; examples include Coal India and Infosys.
Corporate Action
Any action initiated by a company that directly impacts shareholders. This can include the declaration of dividends, bonus shares, or a stock split.
What is a Stock Split?
In a stock split, the number of shares increases, but the price per share decreases, maintaining the same market capitalization. For instance, in SBI’s 2014 stock split:
The SBI board set November 21, 2014, as the record date for the stock split in the ratio of 1:10. Shares with a face value of Rs 10 split into shares of Rs 1 each, resulting in a 1:10 stock split. The stock prices shifted from Rs 2,913 per share to close the day at Rs 297 per share.
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