Primary Market & Secondary Market
A primary market is a market in which corporations sell their securities to investors for the first time. On the other hand, a secondary market is a market in which investors trade the securities already issued with each other.
Financial markets are categorized into primary markets and secondary markets depending on whether the securities traded in them are new or old. Even though secondary markets are much larger than primary markets based on the volume of transactions, they exist primarily to provide liquidity for securities issued by companies in the primary market.
Functions of a Primary Market
Primary markets enable corporations to raise capital by issuing shares of common stock or bonds.
The different types of primary market transactions that a corporation can engage in include public issue, rights issue, and private placement.
- Public issue: a public issue occurs when a corporation offers its shares to public at large. Initial public offering (IPO) is a special case of public issue in which a private company offers its securities to public for the first time.
- Rights issue: a rights issue occurs when a corporation issues new shares to existing shareholders of a company in proportion to their current holding.
- Private placement: a private placement occurs when a corporation sells its shares to a select number of large investors such as pension funds, endowments, etc.
A public issue is underwritten which means that a syndicate of investment banks acts as an intermediary in that it purchases securities from the issuer and sells them to retail investors and earns a profit in the process.
Functions of a Secondary Market
The quality of a primary market depends on the breadth and depth of the secondary market. It is because when an active and efficient secondary market exists, more investors are interested in participating in the primary market for a company’s securities.
The main functions of secondary markets are as follows:
- They provide liquidity to stockholders and bondholders. In other words, they enable investors to convert their securities to cash as and when they want to.
- They provide information about value of a company’s securities. Valuation ratios such as price to earnings (P/E), price to book (P/B), price to sales (P/S), etc. are used by investors to identify good investments.
- They support the primary market transactions of a company’s securities by making the securities attractive to investors.
Secondary markets are either organized exchanges such as the New York Stock Exchange, London Stock Exchange or over-the-counter dealer markets such as NASDAQ.
Summary of Differences
The following table summarizes the main differences between a primary market and a secondary market:
|Primary Market||Secondary Market|
|Nature of securities (new vs old)||Newly issued securities||Securities already issued|
|Trading volume||Small because not all companies issue new securities every day.||Large because thousands of shares of each company changes hand at any time|
|Buyers||Underwriters and investors||Investors|
|Purpose||Allow companies to raise capital for new projects||Support the primary market by providing liquidity and information|