What Is A Secondary Market?

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Investing in financial markets requires knowledge of the length and breadth of the market. There are different types of markets for investors to pitch their tents. There is the primary and secondary market.

In this titbit, we adapted a basic introduction into the secondary market from the FMDQ OTC Learning. It is an eye-opener for anyone who wish to know more and invest in secondary markets.

A secondary market is a type of market where existing shares, debentures, bonds, options, commercial papers, treasury bills and other securities of corporates, governments, etc. are traded. This market enables the buying and selling of previously issued securities.

The secondary market can either be a market where trading of securities is done through an organised or centralised exchange, or a dealer market, popularly known as over-the-counter (OTC), where trading may be done informally without an exchange.

Types of Secondary Markets

Secondary markets are mainly organised in two ways, via a centralised exchange or OTC, however recent electronic facilities slightly blur the traditional distinctions.

Centralised Exchange Market

A centralised exchange is an organised trading system where all buyers and sellers (or their representative agents) interact to buy and sell securities. Transactions tend to be completed through a centralised source. There is a specified number of traders that will trade on that single centralised system. Here, public traders cannot directly trade on these exchanges; they must route their orders through a securities broker who is a member of the exchange. This situation positions the mediator in a powerful position, which is the key disadvantage to this type of trading. However, a key advantage is that this also allows for better transaction enforcement and stricter security. Some examples of this form of secondary markets are the Nigerian Stock Exchange, London Stock Exchange or New York Stock Exchange (NYSE). The more investors participate in a market, the greater the centralisation of that market, and the more liquid the market.

OTC Market

An OTC market is a secondary market where securities are traded directly between two parties. Securities are traded amongst dealers over computerised networks, telephone or other electronic network instead of a physical trading floor, as you may find in a centralised exchange. OTC dealers quote a bid price at which they would buy, and an ask price at which they would sell. An example of an OTC securities market is that of the National Association of Securities Dealers Automated Quotations System (Nasdaq).

Most deals on such markets tend to be institutional in nature and are of sizable volumes. The foreign exchange market globally is an OTC market, and most of the trading in bonds, derivatives and structured products also takes place on such markets. Equities can also be traded in the OTC market. A key advantage of OTC market trading is that terms of a contract do not have to be those specified by an exchange. Market participants are free to negotiate any mutually attractive deal.

A problem, however, arises if securities are not reliably priced, this could impact liquidity and lead to the withdrawal of dealers/buyers from their market making functions, worsening the liquidity problem. It is worth mentioning that recent electronic facilities slightly blur the traditional distinctions between Exchange Traded markets and OTC markets, such as in the case of FMDQ OTC Securities Exchange (FMDQ).

Although it operates in the OTC market it has some similar features to that of an Exchange. For instance, OTC markets generally tend to be decentralised and not well regulated, in the case of FMDQ it is centralised and acts as a self-regulatory organisation (SRO) that is also regulated and accountable to the Securities Exchange Commission (SEC). This role helps mitigate the typical issues (which include price manipulation, fraud, dishonest traders etc.) generally found in OTC markets.

To conclude, securities markets play an important role in the mobilisation of money in a country’s economy. The different market structures solve different needs and is important in determining profitability. Therefore, knowledge of the types of securities markets is essential in determining the best market for effective redistribution of funds.

 

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