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Understanding the Secondary Market: A Comprehensive Guide for Investors

Posted by T.Gowda on 2024-09-10 17:16:53 | Last Updated by T.Gowda on 2024-09-10 17:16:53

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What is meant by the Secondary market?

A secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. The majority of the trading is done in the secondary market. The secondary market comprises equity markets and debt markets.

What is the role of the Secondary market?

For the general investor, the secondary market provides an efficient platform for trading his securities. For the management of the company, secondary equity markets serve as monitoring and control conduct by facilitating value-enhancing control activities, enabling the implementation of incentive-based management contracts, and aggregating information (via price discovery) that guides management decisions.

What is the difference between the primary market and the secondary market?

In the primary market, securities are offered to the public for subscription to raise capital or funds. A secondary market is an equity trading venue in which already existing/pre-issued securities are traded among investors.

What is the role of a stock exchange in buying and selling shares?

The stock exchanges in India, under the overall supervision of the regulatory authority, the Securities and Exchange Board of India (SEBI), provide a trading platform, where buyers and sellers can meet to transact in securities. The trading platform provided by the National Stock Exchange of India (NSE) is an electronic one, and there is no need for buyers and sellers to meet at a physical location to trade. They can trade through the computerized trading screens available with the NSE trading members or the internet-based trading facility provided by the trading members of the NSE.

What is the maximum brokerage that a broker can charge?

The maximum brokerage that can be charged by a broker from his clients as commission cannot be more than 2.5% of the value mentioned in the respective purchase or sale note.

What precautions must one take before investing in the stock markets?

Here are some useful points to bear in mind before you invest in the Market: -

• Make sure your broker is registered with SEBI and the exchanges and do not deal with unregistered intermediaries.

• Ensure that you receive contract notes for all your transactions from your broker within one working day of execution of the trades.

• All investments carry risks of some kind. Investors should always know the risk that they are taking and invest in a manner that matches their risk tolerance.

• Do not be mislead by market rumours, luring advertisements or ‘hot tips’ of the day.

• Make informed decisions by studying the fundamentals of the company. Find out the business the company is into, its prospects, quality of management, past track record etc. Sources of knowing about a company are through annual reports, economic magazines, and databases available with vendors or your financial advisor.

• If your financial advisor or broker advises you to invest in a company you have never heard of, be cautious. Spend some time checking out about the company before investing.

• Do not be attracted by announcements of fantastic results/news reports, about a company. Do your research before investing in any stock.

• Do not be attracted to stocks based on what an internet website promotes, unless you have done an adequate study of the company.

• Investing in very low-priced stocks or what are known as penny stocks does not guarantee high returns. 

• Be cautious about stocks that show a sudden price or trading activity spurt.

• Any advice or tip that claims that huge returns are expected, especially for acting quickly, may be risky and lead to losing some, most, or all of your money.

Products in the Secondary Markets

Following are the main financial products/instruments dealt with in the Secondary market which may be divided broadly into Shares and Bonds:

Shares:

Equity Shares: An equity share, commonly called an ordinary share, represents the form of fractional ownership in a business venture.

Rights Issue / Rights Shares: The issue of new securities to existing shareholders at a ratio to those already held, at a price. E.g. a 2:3 rights issue at Rs.125, would entitle a shareholder to receive 2 shares for every 3 shares held at a price of Rs.125 per share.

Bonus Shares: Shares issued by the companies to their shareholders free of cost based on the number of shares the shareholder owns.

Preference Shares: Owners of these kinds of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid regularly before a dividend can be paid in respect of equity shares. They also enjoy priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank below the claims of the company’s creditors, bondholders/debenture holders.

Cumulative Preference Shares: A type of preference share on which a dividend accumulates if remains unpaid. All arrears of preference dividends have to be paid out before paying dividends on equity shares.

Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company.

Bond: It is a negotiable certificate evidencing indebtedness. It is normally unsecured. A debt security is generally issued by a company, municipality or government agency. A bond investor lends money to the issuer and in exchange, the issuer promises to repay the loan amount on a specified maturity date. The issuer usually pays the bond holder periodic interest payments over the life of the loan.

The various types of Bonds are as follows:

Zero Coupon Bond: Bond issued at a discount and repaid at a face value. No periodic interest is paid. The difference between the issue price and redemption price represents the return to the holder. The buyer of these bonds receives only one payment, at the maturity of the bond.

Convertible Bond: A bond gives the investor the option to convert the bond into equity at a fixed conversion price.

Treasury Bills: Short-term (up to one year) bearer discount security issued by the government as a means of financing their cash requirements.

The secondary market plays a crucial role in the financial ecosystem by providing a platform for investors to trade securities after their initial public offering. It enables liquidity, price discovery, and efficient capital allocation, benefiting both investors and companies. Understanding how the secondary market functions, along with the associated financial instruments like shares and bonds, is essential for any investor. By following the necessary precautions and making informed decisions, one can navigate the market successfully and mitigate potential risks while maximizing investment opportunities.