For example, stocks and bonds purchased in a retirement plan or through a brokerage account are transacted on secondary markets. Let’s say you have two portfolios: one is an employee stock ownership plan and one is with a discount brokerage. When you buy stock directly from the company as with the first plan, it is a primary market transaction. When you buy in the discount brokerage account through stock exchanges, it is a secondary market transaction.
How Secondary Markets Work
Investors trade with one another in secondary markets, rather than the issuing organization. Secondary markets hold their name because when you trade on one, the trading occurs after the asset is already issued on the primary market. While stocks are the most commonly traded security on a secondary market, the mortgage market is another good example to refer to when discussing the secondary market. A financial institution writes a mortgage for a consumer, which creates a mortgage security. Next, the bank or other financial institution can then sell it to Fannie Mae or Freddie Mac on the secondary market to finance the construction and sale of housing, creating a secondary transaction.
Types of Secondary Markets
There are many types of secondary markets, and the way they work might differ depending on how they are structured and what types of assets are being traded. You’ve likely heard of some secondary markets, like the popular stock exchanges. Let’s go over the most common types of secondary markets, with examples:
Stock Exchanges
Public stocks trading on exchanges such as the New York Stock Exchange (NYSE) or the NASDAQ trade on the secondary market. Transactions are handled by brokers who work with market makers to provide bid and ask prices for individual investors and institutions.
Fixed Income Instruments
Fixed income instruments from Treasury bills to corporate bonds all trade on a secondary market. The bond market, however, isn’t as open and liquid as the stock market. You can rarely find a real-time quote for a bond. Instead you work through intermediaries like broker-dealers. Bonds are issued at par value. Then once they are on the secondary market, their prices fluctuate based on factors such as credit, market conditions, and interest rates.
Mortgages
Mortgages are technically a subset of fixed income, but there are enough differences for them to earn their own section. As mentioned, generally, once your mortgage originates it is sold by the lender to a market operator like Freddie Mac, which was chartered by Congress to be a secondary mortgage market. The buyer then pools mortgages together into one big security and sells that to investors who buy the income stream.
Small Business Loans
Government guaranteed small business loans can also be pooled and sold to investors, just like mortgages. This happens most often with the Small Business Administration’s 7(a) loan program. Banks originate loans and then sell the guaranteed portion on a secondary market to a financial institution that pools the loans together. The secondary market provides a guaranteed payment stream for investors, and allows banks to sell loans for a quick premium. The banks can then go out and lend the money again.
Private Companies
Employees who are issued shares of private companies (meaning that no shares are trading on a public stock exchange) often have trouble selling the shares if they need to raise cash to pay taxes or for some other reason. When the shareholders are allowed to sell shares, they do it through online secondary markets where accredited investors will take the shares off their hands. Buyers in this case generally include wealthy individuals, venture-capital firms, hedge funds, private-equity firms, and institutional investors.
Primary Markets vs. Secondary Markets
Stocks
The primary market for stocks is through initial public offerings (IPOs). The company’s management presents the offering to financial institutions and then sells shares to them. The shares then become available on a stock exchange.
Fixed Income
The bond primary market is very similar to the stock one. The issuer tours financial institutions pitching the bond and then sells it to them. The financial institutions then make the bond available for sale on the secondary market, where it trades through broker-dealers.
Mortgages & Small Business Loans
Both of these are originated by banks and non-bank lenders. The lenders underwrite the loan and issue the original money to the borrower. The lender then sells the loan, or part of it, to financial institutions that make it available on a secondary market.
Private Companies
Private companies generally sell shares to venture capital funds or issue them to employees as an incentive or company benefit. This is considered the primary market until or unless the business decides to go public with an initial public offering.
