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Primary Market and Secondary Market: Knowing their Differences

New securities are being issued to the public on a regular basis in the financial market. It is a world where various financial products and services are modified to match every individual.

These financial products are then bought and sold on the capital market. The capital market is subdivided into two segments, the primary market and secondary market.

Knowing what sets them apart from each other is important, especially if you want to understand the capital markets sector.

So before you decide to invest your money in financial assets, you must fully recognize the difference between the primary market and secondary market to have better utilization of savings. In order to do that, we will have to take closer look on their differences.   Primary Market and Secondary Market Infographic

Primary Market

The primary market acts as the first stop in which securities, such as stocks or bonds, can be offered. It is where new securities are issued and become available for trading by individuals and companies.

Read also about The Difference between Stocks and Bonds to learn more.

Also known as the new issue market (NIM), the primary market offers securities on an exchange for corporations, governments, and other public sector institutions through debt-based or equity-based securities.

primary market

The sale of securities is usually facilitated by underwriting groups, such as investment firms. They are in charge of determining an initial price range for a specific security and supervising its sale to investors.

Companies and government entities sell newly issued securities on the primary market to finance expansion and diversification of emerging as well as existing enterprises.

Even though investment banks set the starting price and receive a fee for overseeing sales, a huge portion of the funding still goes to the issuer. Investors also pay less for securities on the primary market. 

Raising Capital or Equity in the Primary Market

There four ways to raise capital or equity in the primary market:

  1. Public Issue

Companies may raise capital through initial public offerings (IPOs) in which they sell securities to the public in the primary market. An IPO as the name suggests, is when a business makes a public offer for the first time to investors and invite them to invest in the shares.

Through this process, the company could raise funds and allow investors to invest in group, therefore making them shareholders or part owners of the business. IPOs can be carried out by way of fixed-price method, book building, or a combination of both.

An IPO is usually done by emerging companies looking to broaden its operations, or by mature corporations that still happens to be privately held. Chinese e-commerce giant Alibaba Group Holding Ltd.’s IPO of $25 billion in 2014 currently holds the top spot for the largest global IPOs of all time.

  1. Rights Issue

If a company decides to raise additional equity capital from existing shareholders, more shares have to be offered to shareholders for a lower cost than the current market price. The amount of shares is presented on a pro-rata basis, known as the rights issue. 

A rights issue allows shareholders to acquire supplementary shares directly from the corporation in proportion to their prevailing holdings, within a certain time. Rights are transferable, which means the holder can sell them on the open market.

Financially struggling companies can utilize right issues to raise money when they really need it. Some use it to lessen their debt, especially when they are unable to borrow more money. The businesses offer shareholders the opportunity to acquire new shares for a lower cost than the prevailing trading price.

  1. Private Placement

This is about selling securities to a few selected investors. It may include large banks, mutual funds, insurance firms, and pension funds.

Private placement has minimal regulatory requirements and conditions that it must follow. It does not have to undergo registration process with the Securities and Exchange Commission (SEC), and the investment needs no prospectus. Financial details are also not released to the public.

Private placements are exempted from registering with the SEC, as stated by the Regulation D of the Securities Act of 1933. They are sold using a private placement memorandum (PPM) and are not publicly marketed.

  1. Preferential Allotment

Preferential allotment takes place when a listed business issues equity shares to a chosen number of investors at a price that may or may not be related to the market price.

The basis of the allotment is decided by the company. It does not rely on any methods, such as pro-rate or others. The company makes the allotment of shares to individuals, enterprises, venture capitalists, or any other financial organizations through a new issue of shares.

Overall, preferential allotment is offered to people interested in acquiring a strategic stake in the company.

Secondary Market

The secondary market is the place to buy and sell existing securities that were first issued in the primary market. It does not provide financing to a company, as it is not involved in transaction.

The exchange here is between a buyer and a seller, with the stock exchange facilitating the trade. The issuing company is not included in this market, except when a company stock buyback occurs.

The New York Stock Exchange (NYSE) and the Nasdaq Stock Market are just some of the popular secondary markets. Investment banks, as well as corporate and individual investors can also buy and sell mutual funds, bonds, and mortgages on this market.

Check out What You Need to Learn about the Stock Market to know more.

secondary market

As regards to who can buy securities on the secondary market, anyone can purchase them, provided that they can pay the price for which the security is traded.

Small investors can buy and sell securities on secondary markets, since they are not excluded from IPOs because of the small amount of cash they represent.

Brokers involved in the trading of the securities here are usually the intermediaries. They buy the securities on behalf of the investors, with the fee to the investor consisting of the commission paid to the broker.

The number of secondary markets is also constantly increasing, as new financial instruments are being introduced. In the case of mortgages, many secondary markets may be present.   

Two Types of Market on the Secondary Market

  1. Auction Market

This is where buyers place competitive bids and sellers present competitive offers simultaneously. Buyers indicate the highest price they are willing to pay and sellers indicate the lowest price they are willing to accept. Compatible bids and offers are then put together, and the trade is carried out.

Investors do not have to look for profitable options. It is because all buyers and sellers are being called at the same location. Everything is announced in public and interested investors can decide easily.        

The NYSE is one the world’s leading auction markets. Its specialists act as auctioneers and pair orders to promote an efficient marketplace.

Even though most the trading is done using a computer, this type of market can also be operated by way of an open outcry, where buyers and sellers call out prices to each other out loud.

  1. Dealer Market

In a dealer market, the activity is limited to dealers acting as principals for their own accounts. Brokers acting as agents for their clients cannot participate here.

A distinction to this market is that it is an over-the-counter (OTC) market. Stocks are not traded over stock exchanges; rather they are traded on the pink sheets or on over-the-counter bulletin boards (OTCBBs).   

Participants do not convene at a common place. Instead, buying and selling of securities is electronically carried out. Interested sellers convey their offer via a specific electronical device, which are then passed on to buyers using the device of dealers.

Dealers have a variety of securities and they profit through the selling. A large number of dealers work within this market, with the goal of providing the best offer to their investors.

Bonds and foreign exchange mainly trade in dealer markets, while the Nasdaq is an example of an equity dealer market.

What’s More

Prices in the primary market are usually established in advance, while secondary market prices are set based on fundamental factors of supply and demand.

If most investors considered the stock optimistic and quickly buy it, its price will go higher. If a company loses support from investors or is unable to generate enough profits, its stock price will typically fall, as demand for that security drops.         

Know more about stocks’ condition by reading the Bull and Bear Markets: Breaking Down the Differences.

Conclusion

Markets can be physical or virtual. Examples of capital markets are the markets for buying and selling securities, which include the primary market and secondary market.

These two markets play a big role in the movement of money in the economy. The primary market promotes direct communication between the company and the investor, while the secondary market enables brokers to help investors in buying and selling securities.

Through both of these markets, individuals can purchase financial assets from which they may receive returns and build their wealth.

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