Notes on Secondary Market: Definition, Instruments and Features

After reading this article you will learn about:- 1. Definition of Secondary Market 2. Instruments 3. Features.

Definition of Secondary Market:

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

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

Instruments of Secondary Market:

The financial products/instruments which are dealt in the secondary market are:

1. Equity:

The ownership interest in a company of holders of its common and preferred stock.

The various kinds of equity shares are:

Equity Shares:

An equity share commonly referred to as ordinary share also represents the form of fractional ownership in which a shareholder, as a fractional owner, undertakes the maximum entrepreneurial risk associated with a business venture. The holders of such shares are members of the company and have voting rights.

Right Issues/Rights Shares:

The issue of new securities to existing shareholders at a ratio to those already held.

Bonus Shares:

Shares issued by the companies to their shareholders free of cost by capitalization of accumulated reserves from the profits earned in the earlier years.

Preferred Stock/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 dividend can be paid in respect of equity share. They also enjoy priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claim rank below the claims of the company’s creditors, bond holders/debenture holders.

Cumulative Preference Shares:

A type of preference shares on which dividend accumulates if remains unpaid. All arrears of preference dividend have to be paid out before paying dividend 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.

Participating Preference Shares:

The right of certain preference shareholders to participate in profits after a specified fixed dividend contracted far is paid. Participation right is linked with the quantum of dividend paid on the equity shares over and above a particular specified level.

Security Receipts:

Security receipt means a receipt or other security, issued by a securitization company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitization.

Government securities (G-Secs):

These are sovereign (credit risk-free) coupon bearing instruments which are issued by the Reserve Bank of India on behalf of Government of India, in lieu of the Central Government’s market borrowing programme. These securities have a fixed coupon that is paid on specific dates on half-yearly basis. These securities are available in wide range of maturity dates, from short dated (less than one year) to long dated (up to twenty years).

Debentures:

Bonds issued by a company bearing a fixed rate of interest usually payable half yearly on specific dates and principal amount repayable on particular date on redemption of the debentures. Debentures are normally secured/charged against the asset of the company in favour of debenture holder.

Bond:

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:

1. 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.

2. Convertible Bond:

A bond giving the investor the option to convert the bond into equity at a fixed conversion price.

Commercial Paper:

A short term promise to repay a fixed amount that is placed on the market either directly or through a specialized intermediary. It is usually issued by companies with a high credit standing in the form of a promissory note redeemable at par to the holder on maturity and therefore, doesn’t require any guarantee. Commercial paper is a money market instrument issued normally for tenure of 90 days.

Treasury Bills:

Short-term (up to 91 days) bearer discount security issued by the Government as a means of financing its cash requirements.

Features of Secondary Market:

1. Buyback of Shares:

It is a system for any organisation to invest by buying shares from other investors in the market. This system is regulated by SEBI and Company Act. The provisions regulating buyback are contained under the companies Act 1956 which were amended in 1999.

The shares may be bought back by any company under the prescribed rule and regulations depending one or more of the following reasons:

i) To increase promoters holdings,

ii) To increase earning per share,

iii) Rationalise the capital structure by writing off capital not represented by available assets,

iv) To support share value, and

v) To pay surplus cash not required by business.

2. Corporate Action:

The corporate actions is an action or event initiated by a company which has direct impact on the shareholders of the company. In such circumstances the share holders may respond to the company’s decision. Corporate action may include declaration of dividend, issue of bonus shares, splitting shares into smaller denominations etc., such actions impact the market price of the shares.

3. Index:

It is an indication of market trend, showing specified portfolio of share price’s movements. It is a basket of securities and the average price movement of the basket securities indicates the index movement.

4. Sensex:

Sensex is an index based on shares traded on the Bombay Stock Exchange. The Sensex and the NIFTY are barometers of the Indian market.