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The Structure of the Secondary Market

The Structure of the Secondary Market. When securities are traded between investors, issuers no longer receive any cash proceeds. Investors usually initiate securities purchases in the secondary markets by calling a security brokerage house. After an account has been opened, a broker relays the client’s order to a dealer making a market in the securities the investors want. Since the secondary market involves the trading of securities initially sold in the primary market, it provides liquidity to the individuals who acquired these securities.


The Structure of the Secondary Market

The structure of the secondary market is given below:

structure of secondary market

Secondary markets may be categorized into four groups as:

  1. The first market called organized stock exchanges,
  2. The second market termed as over-the-counter (OTC) market,
  3. The third market and
  4. Fourth market.


Read About Basic Functions of the Secondary Market.

Their position and status are given in the following manner:


Organized Exchanges.

In the secondary markets, the individual investor can sell securities to another investor without the presence and involvement of the firm that issued the securities. Such type of secondary trading takes place on the organized stock exchanges.


The OTC Market.

In past times securities were traded over-the-counter of banks or in the offices of security dealers. Today over-the-counter trades occur in brokers’ offices, dealers’ offices, homes, over the phone, electrically, and any place or even any transport whole over the country and in foreign countries. The over-the-counter (OTC) market includes trading in all securities not listed on one of the exchanges. It also includes trading in listed stocks referring to the third market. Though the unlisted securities trading market, OTC is one of the most modern and efficient securities markets in the world. OTC market is not physically located market in any one place. It consists of a number of broker-dealers throughout the country who are linked together through an e-mail or electronic communications network. Any security can be traded on the OTC market as long as a registered dealer is willing to make a market in the security. The OTC market competes with investment bankers and organized exchanges as OTC dealers can operate as both a primary and a secondary market.

Risk-free securities, government, and corporate bonds, common stocks, etc. are traded in the over-the-counter market. Corporate bonds are preferably traded in the OTC market because organized exchanges prefer to trade stocks of corporations instead of their bonds as the commissions of common stock are higher. The OTC broker-dealers are organized as sole proprietorship’s, some as partnerships, and many as corporations.


However, the broker-dealers in the OTC market can be categorized as follows:

OTC House:

An OTC house is specialized in OTC issues and rarely belongs to an exchange.


Investment Banking House:

An investment banking house is specialized in IPOs and may diversify by acting as the dealer in both listed and OTC securities.


Commercial Bank:

A commercial bank may be an OTC dealer or broker when it trades securities.


Stock Exchange Member House: 

It can work as an OTC broker or dealer having a separate department specifically formed to carry on trading in the OTC market.


Bond house :

A bond house may deal in government and autonomous bond issues trading in OTC.


Third and Fourth Markets.

The secondary markets can occasionally be categorized into four parts.

  • The first market represents organized exchanges where listed securities are traded.
  • Second market is the over-the-counter market where the unlisted securities are traded.
  • The third market represents over-the-counter trading of securities which are listed on an exchange while >> the fourth market represents direct trading between two investors bypassing the activities usually done by the brokerage firms.


The Third Market.

The third market is an OTC marketing stock associated with an exchange. Although most transactions in listed stocks take place on an exchange, a brokerage firm without being a member of an exchange can make a market in a listed stock. A number of broker-dealers who are not members of Dhaka Stock Exchange (DSE) can make markets in stocks of DSE listed firms. The OTC dealers making up the third market provide minimal services for their clients-only execution of buy-sell orders and record keeping. They are always ready to execute large trades at much lower commissions. The success or failure of the third market depends on whether the OTC market in these stocks is as good as the exchange market and whether the relative cost of the OTC transaction compares favorably with the cost on the exchange.


The Fourth Market.

The method of reducing commission costs in the security transactions sometimes would be the complete elimination of the broker-dealer firm as a middleman. When one investor sells security directly to another investor without a broker-dealer as a middleman, they are said to be trading in the fourth market. In all most all cases, both parties involved in each transaction of the fourth market are institutions. Direct investor-to-investor trades occur through a communications network between block traders. A block is a single transaction involving 10,000 or more shares. The participants of the fourth market bypass the normal dealer system. However, the organizer of the fourth market collects only a small commission for helping to arrange a block transaction.



Fig. The Structure of the Secondary Market



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About Mohammed Ahaduzzaman

Mr. Zaman is a Founder and Freelance Writer @ BBALectures Blog! Blogging is his passion. He loves writing on Entrepreneurship, Finances, Accounting, HR and Business Issues. By profession, He serving as Accounting Professional at Zaman Accounting.

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