When a company publicly sells new stocks and bonds for the first time, it does so in the primary capital market. This market is also called the new issues market. In many cases, the new issue takes the form of an initial public offering (IPO). When investors purchase securities on the primary capital market, the company that offers the securities hires an underwriting firm to review it and create a prospectus outlining the price and other details of the securities to be issued.
All issues on the primary market are subject to strict regulation. Companies must file statements with the Securities and Exchange Commission (SEC) and other securities agencies and must wait before their filings are approved before they can go public.
Companies that issue securities through the primary capital market may hire investment bankers to obtain commitments from large institutional investors to purchase the securities when first offered. Small investors are often unable to purchase securities at this point because the company and its investment bankers want to sell all of the available securities in a short period of time to meet the required volume, and they must focus on marketing the sale to large investors who can buy more securities at once. Marketing the sale to investors can often include a road show or dog and pony show, in which investment bankers and the company’s leadership travel to meet with potential investors and convince them of the value of the security being issued.
Prices are often volatile in the primary market because demand is often hard to predict when a security is first issued. That’s why a lot of IPOs are set at low prices.
A company can raise more equity in the primary market after entering the secondary market through a rights offering. The company will offer prorated rights based on share investors already own. Another option is a private placement, where a company may sell directly to a large investor such as a hedge fund or a bank. In this case, the shares are not made public.
Capital or equity can be raised in the primary market by any of the following four ways-
(i) Public Issue
As the name suggests, public issue means selling securities to the public at large, such as IPO. It is the most vital method to sell financial securities.
(ii) Rights Issue
Whenever a company needs to raise supplementary equity capital, the shares have to be offered to present shareholders on a pro-rata basis, which is known as the Rights Issue.
(iii) Private Placement
This is about selling securities to a restricted number of classy investors like frequent investors, venture capital funds, mutual funds, and banks comes under Private Placement.
(iv) Preferential Allotment
When a listed company issues equity shares to a selected number of investors at a price that may or may not be pertaining to the market price is known as Preferential Allotment.
The primary market is also known as the New Issue Market (NIM) as it is the market for issuing long-term equity capital. Since the companies issue securities directly to the investors, it is responsible to issue the security certificates too. The creation of new securities facilitates growth within the economy.
The secondary market is where securities are traded after the company has sold its offering on the primary market. It is also referred to as the stock market. The New York Stock Exchange (NYSE), London Stock Exchange, and Nasdaq are secondary markets.
Small investors have a much better chance of trading securities on the secondary market since they are excluded from IPOs. Anyone can purchase securities on the secondary market as long as they are willing to pay the asking price per share.
A broker typically purchases the securities on behalf of an investor in the secondary market. Unlike the primary market, where prices are set before an IPO takes place, prices on the secondary market fluctuate with demand. Investors will also have to pay a commission to the broker for carrying out the trade.
The volume of securities traded varies from day to day, as supply and demand for the security fluctuates. This also has a big effect on the security’s price.
Because the initial offering is complete, the issuing company is no longer a party to any sale between two investors, except in the case of a company stock buyback. For example, after Apple’s Dec. 12, 1980, IPO on the primary market, individual investors have been able to purchase Apple stock on the secondary market. Because Apple is no longer involved in the issue of its stock, investors will, essentially, deal with one another when they trade shares in the company.
The secondary market is further divided into two kinds of market:
(i) Auction Market
An auction market is a place where buyers and sellers convene at a place and announce the rate at which they are willing to sell or buy securities. They offer either the ‘bid’ or ‘ask’ prices, publicly. Since all buyers and sellers are convening at the same place, there is no need for investors to seek out profitable options. Everything is announced publicly and interested investors can make their choice easily.
(ii) Dealer Market
In a dealer market, none of the parties convene at a common location. Instead, buying and selling of securities happen through electronic networks which usually fax machines, telephones or custom order-matching machines.
Interested sellers deliver their offer through these mediums, which are then relayed over to the buyers through the medium of dealers. The dealers possess an inventory of securities and earn their profit through the selling. A lot of dealers operate within this market and therefore, a competition exists between them to deliver the best offer to their investors. This makes them deliver the best price to the investors. An example of a dealer market is the NASDAQ.
The secondary markets are important for price discovery. The market operations are carried out on stock exchanges.