Secondary Market - Explained
What is a Secondary Market?
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Table of ContentsWhat is a Secondary Market?How Does a Secondary Market Work?The Differences between Primary and Secondary Markets Setting Prices in the Secondary Market Private Equity Secondary Markets
What is a Secondary Market?
A secondary market (also known as the aftermarket) is a type of financial market that facilitates the sale and purchase of previously-issued securities by investors. These securities are typically shares, bonds, investment notes, futures and options. All commodity markets as well as stock exchanges are classified as secondary markets.
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How Does a Secondary Market Work?
Secondary markets are most predominantly used to trade stocks. However, there are several other uses of such markets; for instance, secondary markets facilitate trading in mutual funds as well as mortgage purchases by government enterprises such as the Federal National Mortgage Association (popularly referred to as Fannie Mae) and the Federal Home Loan Mortgage Corporation (popularly referred to as Freddie Mac). The term secondary markets can also be used as a synonym for markets that facilitate trade in used goods. Moreover, in present times, the definition of a secondary market has expanded to include cryptocurrency exchanges. In the context of a security market though, a secondary market is thus named because they facilitate secondary transactions involving securities.
The Differences between Primary and Secondary Markets
A primary market is a financial market that facilitates the sale of a stock or a bond that has been issued by a company for the first time directly to the investors. A common example of a primary market transaction is an Initial Public Offering (IPO). An IPO involves a direct transaction between the seller, which is the investment bank underwriting the offering, and the buyer, who is the investor purchasing the IPO. Such an IPO transaction only occurs in the primary market. In sharp contrast, a secondary market is a financial market that facilitates those transactions that occur between investors. For example, an investor that purchased a stake in a company through an IPO can choose to sell his holdings to other investors in a secondary market. It may be observed in the above example that neither the company that issued the IPO, nor the underwriting bank will receive any proceeds from the sale of a security in the secondary market.
Setting Prices in the Secondary Market
Unlike primary markets where the prices of tradable securities are often determined in advance, in a secondary market, prices are exposed to the basis market forces of supply and demand. For a stock that demonstrates a high potential for an increase in value in the future, its current market price will also increase. Conversely, if a company posts earnings that are well below investor estimates, it falls out of favor of investors, and as a result, its market price dwindles.
Private Equity Secondary Markets
Private equity secondary markets are financial markets that facilitate the sale and purchase of previously-issued investor commitments to private equity funds. The NASDAQ Private Market and SecondaryLink are examples of private equity secondary markets that emerged during the turn of this century as an aftermath of the Sarbanes-Oxley Act of 2002.