Secondary Market
What is Secondary Market?
The secondary market is where investors trade securities that already exist, so the payment goes to the selling investor rather than to the original issuer.
Once a security has been issued it trades between investors in the secondary market, either on an organized exchange or over the counter through dealers. The issuer is not a party to those trades and gets none of the proceeds. What the secondary market supplies instead is liquidity and a continuous price: an investor can sell without waiting for a bond to mature, and the trading price tells everyone what the market thinks the claim is worth. That liquidity feeds back into the primary market, because investors will pay more for a new issue they know they can sell later. Central bank open market operations are secondary market trades too, since the Fed buys and sells government securities that already exist.
Secondary Market: a worked example
An investor buys a new $1,000 bond with a 5 percent coupon at issue, paying $1,000 that goes to the issuer. Two years later, with market interest rates higher, the investor sells the bond to a second investor for $950. That $950 goes to the seller, not to the issuer. The new owner still collects the same $50 coupon each year, which on a $950 purchase price works out to a current yield of about 5.3 percent ($50 divided by $950). The issuer's payments never changed; only the price of the claim did.
The mistake students make with secondary market
Students think that when a share price falls, money drains out of the company, and that heavy trading volume raises funds for the firm. Secondary market trades only move ownership and cash between investors, leaving the company's bank balance untouched. Share prices still matter to a firm, since they set the terms of any future issue and affect what its stock is worth as payment or collateral, but the trading itself is not company income.
Secondary Market questions
Is the stock market a primary or secondary market?
A stock exchange is overwhelmingly a secondary market, because nearly every trade is one investor selling existing shares to another. It acts as a primary market only when a company actually issues new shares, such as at a public offering. The same venue hosts both, but the two kinds of transaction are different.
Why does the secondary market matter if the issuer gets no money?
The secondary market matters because it makes securities liquid and prices them continuously, which lowers what issuers must pay to raise money in the first place. An investor who knows a bond can be sold at any time will accept a lower interest rate on it. Those prices also signal how the market values a firm and its debt.
What is the difference between an exchange and an over-the-counter market?
An exchange is a centralized, regulated venue with standardized listings and publicly posted quotes, while an over-the-counter market is a network of dealers trading directly with each other. Most stocks trade on exchanges, and most bonds and currencies trade over the counter. Both are secondary markets.
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