The Secondary Market (sometimes known as the aftermarket) is a type of finance market where existing securities, such as stocks and bonds are bought and sold. The most obvious example is a Stock Exchange or Stock Market. Major global stock exchanges are extremely liquid secondary markets trading in stocks of publicly companies. The New York Stock Exchange, London Stock Exchange, Nasdaq and the Tokyo Stock Exchange are generally seen as the busiest exchanges on the planet. A secondary market where investors sell to other investors and contrasts with an Initial Public Offering (IPO) where securities are issued which were not previously available to the public.
A secondary market exists for a variety of assets from bonds & stocks to FOREX and commodities to name but a few. The market can be fragmented or centralized and can range from a high degree of liquidity to being very illiquid. Bond and structured product trading is generally done “over-the-counter” in the OTC market performed by one broker phoning the bond desk of another broker-dealer. Mortgage Backed Securities (MBS), which are home loans bundled together and traded as a single product, occur in the secondary mortgage market.
Secondary Market Characteristics
One of the defining characteristics of the secondary market is liquidity. As securities, in this case stocks, are transferred from one investor or trader to another, it is vital the market has sufficient liquidity. Liquidity enables traders to buy and sell products instantly without affecting the current market value of the asset. If this is not possible, and the asset displays a wide bid ask spread, traders and speculators will generally avoid the asset. This lack of liquidity is common amongst smaller cap stocks. For this reason, many small firms involved in mergers & acquisitions are not included in the Merger Arbitrage Limited T20 Portfolio of merger arbitrage investment opportunities. The reverse therefore is also true as more market participants generally indicate higher liquidity levels.
This higher level of liquidity leads to more accurate price discovery of the asset. This in turn helps ensure capital flows to where it is needed. Superior firms attract more investment and a higher price thus making hostile takeovers less likely. An accurate stock price will also help maintain the correct balance between equity and debt finance.
Secondary Capital Markets Characteristics
Small investors are often excluded from IPO and therefore have to make stock purchases in the secondary market. Anyone from first time investors to experienced speculators can purchase stocks. All that is required is an account with a broker and the required funds. Broker purchases on behalf of the investor are typically done in the secondary market and it is here the investors can open a short position by shorting the desired stock. Market volatility can cause these prices fluctuate with supply and demand and are known as being continuous. This is in contrast to the primary market where IPO prices are fixed and take place on a given date. Another factor effecting the price of the stock is the volume of securities traded which can vary wildly on a daily basis. For supplying this service, investors will have to pay a commission to the broker although intense competition is phasing this practice out. Brokerage houses are instead having to generate alternative income streams such as selling live data to account holders in order to make accurate real time trades.
Prices for Contracts for Difference (CFD) are based on the assets traded in the secondary markets. These services are not actually secondary markets themselves as not assets is traded. Simply the difference in asset value multiplied by the quantity held is transferred from one account to another on a regular basis.
