Functions of Secondary Market
Functions of Secondary Market: The secondary market provides an organized place and the mechanism for trading in securities. They also ensure that the deals struck in the stock are fair and within the framework of law. The efficient functioning of the stock exchange creates a conductive climate for an active and growing primary market for new issues.
An active and healthy secondary market in existing securities leads to better psychology of expectations; considerable broadening of investment enquiries renders the task of raising resources by entrepreneurs easier.
Good performance and outlook for equities in the stock exchanges imparts buoyancy to the new issue market. The good stock exchange facilities the following important activities in the economy of a country: i. Favorable climate for growth of primary market ii. Widening of investment opportunities for the investor iii. Improving availability of resources for the business enterprises iv. Buoyancy in new issues v. Increasing confidence among the players of the market Important functions 1.
Provide a continuous market: It is the important objective of the secondary market to ensure stability in price as the trading activity progresses. The stock market achieves this aim by providing a continuous market infrastructure to the investor, thereby ensuring liquidity in the market. Some important characteristics of a continuous market are: i. Frequency of trades; ii. Small spread between bid and ask prices; iii. Immediate execution of order; iv. Change in price being minimum as the transaction takes place; The enefits of continuous market are that it creates marketable liquid investments and facilitates collateral lending. 2. Frequency of sales: A market will be liquid only when a buyer/ seller can find seller/buyer. If there are no buyers/sellers for some securities or there is long wait before a buyer/ seller can find counterparty, such market are called illiquid markets. The primary criterion for a good market is whether investors can sell their portfolio holding quickly with minimal price fluctuation at the time of sale.
Liquidity occupies a central place in evaluating the efficiency of exchange. The market should have three important dimensions of liquidity. They are: i. Depth ii. Breadth iii. Resilience Depth refers to the situation wherein buy and sell orders are available at the quoted price for the desired quantity. If it is not available, then the market is termed as shallow market. The number of the transaction or the number of orders determines the breadth of the market. Otherwise the market is known as thin.
The response to orders to changes in price reflects the resilience of the market. 3. Empirical measurement of liquidity: Empirically, liquidity is measured by the number of days a company’s share is traded, out of the number of days in the year, when the market is open. The number of days particular share is being traded reflects the liquidity of the market. If it is traded actively 50%of the days when the market is open, then it is termed as liquid. The variation in price of the share from one trading day to another also determines the liquidity of the share.
If the difference between the lowest asked(or offered) price and highest bid-price is wide, the market is said to lack depth and considered shallow. Actually bid- asked spread is an inverse measure of liquidity. ‘ Tick’ as the minimum difference in rates between two orders on the same side i. e. , buy or sell entered on the system for a scrip. Trading in scrips listed on BSE is done with the size of 5 paise, it is 1 paise, in case of mutual funds and others to encourage orders at finer rates and improve liquidity.
In United states, variation of one –eighth point in the price from the immediate trade is considered liquid. In our country, the minimum tick start from 0. 25. 4. Fair price determination: The prices in the stock market are determined by the interplay of the forces of supply and demand. When the prices are going up, it is termed as bull phase and when the prices are going down, it is termed as bear phase. As seen earlier active, bidding and two-way auction trading takes place in the stock exchange. The result is as near a market for free trading and free competition, as can be found anywhere.
The bargains that are struck are at the fairest price, determined by the basic laws of supply and demand. At time large scale speculator activities raise the price of the share. But such activities are ephemeral in nature. There is no fundamental relationship between book value, par value and market value of share, because the share price may experience a boom if there is large scale investment from an individual or mutual fund company and also during such period too much money chases a few shares.
The performance of the stock exchange is also subject to speculation, which at times, drives up the prices above the investment worth and at others, below it. Under the normal circumstances, one would leave the situation to the forces of the market- what the buyers and sellers willing to bid and to offer. But in India, conscious policy is adopted to make shares attractive to the foreign institutional investors who evaluates our market, in relation to the other emerging markets. The stabilization of the stock market prices around a reasonable level would be desirable. . Aid to Financing Activities: Listed company finds it helpful to sell further issues of their shares in the primary market based on the good performance of their earlier ones. An active market and the good market price’s for the company’s shares makes the task of raising funds through further issues easier. This facilitates the company to command good price for the subsequent primary issue in the market. Rights themselves have an immediate and a wide market in the stock exchanges, provided the price including the premium reflects a fair price.
Thus the stock exchanges enable a company to market further issues successfully by creating a continuous market for the rights. 6. Other allied functions: * The market prices established in the stock exchange trading are useful for tax purpose. * The stipulation on disclosure and transparency ensures that the investors have access to information on the listed companies, particularly with regards to their financial condition. * It serves to protect the investor’s interest by eliminating the dishonest and irregular practices rampant in the brokerage trade. To ensure a measure of safety and fair dealing to protect investors interest. * To provide the instant valuation of securities caused by changes in the internal environment. * To induce companies to improve performance since the market price at the stock exchanges reflects the performance and this market price is readily available to investors. * Secondary marketing is vital to an efficient and modern capital market. * In the secondary market, securities are sold by and transferred from one investor or speculator to another. * Risk management