What are secondary stocks in the market

Securities - from launch to trading

As is well known, securities such as stocks or bonds are traded on the financial markets. In this context, the exchange plays just as much a role as over-the-counter trading on the OTC market. There is also the general distinction between the primary market and the secondary market. But what is what?

Primary market and secondary market: 2 worlds

The question also arises for non-investors. The European Court of Justice (ECJ) recently ruled that bond purchases by the ECB on the secondary market to support troubled euro countries are not prohibited public financing.

First of all: The secondary market should not be confused with the over-the-counter market. It includes this as well as trading on the stock exchange. Securities are freely traded on the secondary market after they have been issued on the primary market. Investors have nothing to do with the primary market.

Primary market: workshop for securities

The issue of shares or bonds with which companies or states finance themselves takes place on the primary market. If shares are issued by a company for the first time, it is an IPO (Initial Public Offering).

Investment banks buy the securities, with the demand determining the amount of the paper. These banks are known as consortium banks. They then make the securities tradable so that investors can subscribe to them - on the secondary market.

Secondary market: trading in supply and demand

As soon as the market launch is completed, the actual trading and thus the price adjustment take place on the secondary market. The courses are provided by the first owners, the banks.

As so-called market makers, you set the ask and bid prices at which you as an investor can buy or sell the paper. The difference is the trading margin, the spread on which the providers make money. The higher the buying price than the selling price, the more expensive the paper is. That in turn depends on its liquidity. The easier it is to trade, the cheaper it is.

Unlike stocks, bonds are primarily traded over the counter in the secondary market. The reason lies in the complex pricing due to the numerous types of bonds with a wide variety of game options between term, interest rate and credit rating. The prices change continuously due to the individual variables, which makes it difficult to list all current prices on the stock exchange.

Primary market taboo for the central bank

After all this, the dispute over the legal admissibility of a bond purchase program by the ECB is understandable. The courses and prices are determined by the buying behavior of investors on the secondary market. If the central bank were to buy government bonds on the primary market, it would pre-empt this process, which would constitute monetary government financing. It would buy the bonds directly from the state, which is forbidden according to the EU treaties.

It was controversial whether indirect purchase on the secondary market is also permissible. Specifically, it was about the bond purchase, known as OMT (Outright Monetary Transactions), which the ECB decided in 2012 as an emergency program for ailing euro countries.

The aim of a government bond purchase by the ECB is to lower the interest rates on these papers. But that has repercussions on the primary market: lower interest rates on the secondary market enable a state to offer lower interest rates with new issues on the primary market.

Requirements by the European Court of Justice

A corresponding lawsuit was submitted by the Federal Constitutional Court to the ECJ for a decision. In turn, he decided in June that buying on the secondary market is permissible, provided certain rules are followed.

This includes that the ECB only buys bonds when a market price has already formed on the secondary market. A minimum period is observed. In addition, decisions about purchases and their size are not announced in advance in order to prevent interest rate speculation.

Judgment misjudges realities

Since then, the ECJ ruling has been widely criticized for ignoring economic mechanisms of action. The question arises as to what a waiting period between the issue on the primary market and the purchase on the secondary market can bring about.

If the first-time buyer knows that he can pass the bonds on to the central bank, this already distorts pricing. If the ECB buys bonds en masse, this dries up the market and robs investors of the chance of fair conditions.

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