What would happen if we didnít have secondary mkts
All of us may not have participated in a primary market transaction, but odds are that most of us who are involved with the world of finance and financial instruments have participated in a secondary market transaction.
The primary market is where corporations issue shares and bonds to investors. It is also the arena where governments issue bonds to the public.
If a company is issuing equity shares for the very first time, it is termed as an initial public offering (IPO). Subsequent offerings are termed as follow-on public offerings (FPOs). Once the initial transaction between the issuer and the investor is consummated, subsequent transactions between two investors are termed as secondary market transactions. Thus, primary markets facilitate the raising of capital by companies and governments. Secondary markets serve to facilitate transfer of ownership of securities from one investor to another.
What would happen if we did not have a secondary market? Let us consider bonds first. Most of them have a finite lifespan. If we were to invest in a bond with 20 years to maturity, we would have no option but to hold it for 20 years. For equity shares, the issue is more serious as these do not have a maturity date. The only option for an investor would be to hand it down from generation to generation, and it could obviously never leave the family. This is obviously not a very satisfactory arrangement.
One of the key reasons as to why we invest in financial securities is because these instruments can be easily converted into cash at any point in time. Securities which can be easily converted into cash are termed as liquid securities.
There is another reason why most investors require access to secondary markets. All of us are instinctively risk averse and believe in the principle of diversification. For instance, if I were to bestow you with R10 million in cash, would you invest the entire amount in Infosys shares? Quite obviously you would not. First, you would not invest the entire amount in the stock market. You may invest a part in stocks, a portion in bonds, and possibly even a part of it in real estate or gold.
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