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Thesecondary market, also called theaftermarket andfollow on public offering, is thefinancial market in which previously issuedfinancial instruments such asstock,bonds,options, andfutures are bought and sold. The initial sale of thesecurity by the issuer to a purchaser, who pays proceeds to the issuer, is theprimary market.[1] All sales after the initial sale of the security are sales in the secondary market.[citation needed] Whereas the term primary market refers to the market for new issues of securities, and "[a] market is primary if the proceeds of sales go to theissuer of the securities sold," the secondary market in contrast is the market created by the later trading of such securities.[2]
With primary issuances of securities orfinancial instruments (the primary market), often anunderwriter purchases these securities directly fromissuers, such ascorporations issuingshares in aninitial public offering (IPO) orprivate placement. Then the underwriter re-sells the securities to other buyers, in what is referred to as a secondary market or aftermarket (or a buyer in contrast may buy directly from the federal government, in the case of a government issuingtreasuries).[3]
The secondary market can be for a variety of assets, that can vary from stocks to loans, from fragmented to centralized, and fromilliquid to very liquid.
The majorstock exchanges are the most visible example of liquid secondary markets—in this case, for stocks of publicly traded companies. Exchanges such as theNew York Stock Exchange,London Stock Exchange, andNasdaq Stock Market provide centralized, liquid secondary markets for investors who wish to buy or sell stocks that trade on those exchanges. Most bonds andstructured products trade "over the counter", or by phoning the bond desk of one’sbroker-dealer. Loans sometimes trade online, using a loan exchange.[4]
Another usage of "secondary market" is to refer to loans which are sold by amortgage bank to investors such asFannie Mae andFreddie Mac. The term "secondary market" is also used to refer to the market for anyused goods orassets, or an alternative use for an existing product or asset where the customer base is the second market (for example, corn has been traditionally used primarily for food production and feedstock, but a "second" or "third" market has developed for use in ethanol production).[5]
In the secondary market, securities are sold by and transferred from one buyer to another. It is therefore important that the secondary market be highlyliquid. Originally, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly; this is how stock exchanges originated (seeHistory of the Stock Exchange). As a general rule, the greater the number of investors that participate in a given marketplace, and the greater the centralization of that marketplace, the more liquid the market.[citation needed]
Accurate share price allocates scarce capital more efficiently when new projects are financed through a new primary market offering, but accuracy may also matter in the secondary market because: 1) price accuracy can reduce the agency costs of management, and makehostile takeover a less risky proposition and thus movecapital into the hands of better managers; and 2) accurate share price aids the efficient allocation of debt finance whether debt offerings or institutional borrowing.[6]
The term may refer to markets in things of value other than securities. For example, the ability to buy and sellintellectual property such aspatents, or rights to musical compositions, is considered a secondary market because it allows the owner to freely resell property entitlements issued by the government.[7] Similarly, secondary markets can be said to exist in somereal estate contexts as well (e.g., ownership shares oftime-share vacation homes are bought and sold outside of the official exchange set up by the timeshare issuers). These have very similar functions as secondary stock and bond markets in allowing for speculation, providing liquidity, and financing throughsecuritization. This facilitates liquidity and marketability of the long-term instrument. It also provides instant valuation of securities caused by changes in the environment.[8]
Private-equity secondary market refers to the buying and selling of pre-existing investor commitments toprivate-equity funds. Sellers of private-equity investments sell not only the investments in the fund, but also their remaining unfunded commitments to the funds.[9]
Due to the increased compliance and reporting obligations on U.S. public companyboards of directors and management and publicaccounting firms enacted in theSarbanes–Oxley Act of 2002, private secondary markets began to emerge, such asSecondMarket and SecondaryLink. These markets are generally only available toinstitutional oraccredited investors, and allow trading of unregistered and private company securities.[citation needed]
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