Do you know What is a Primary Market? What is a Secondary Market? If yes, great! If not, we are here to discuss the key differences between Primary Market vs. Secondary Market.
Generally speaking, market is a place of exchange. Goods, services, ideas, money, you name it. The initial idea was a single gathering of people where people could gather and do such economic activities.
Basically, market as a word doesn’t limit itself to only a place because it is more of an idea. Let’s get more into it.
What is a Primary Market?
If you have some idea what it is, read from the next para. So, you know how stock markets are this massive structures and are constantly operating by buying and selling companies and its debt with some wannabe Gordon Gekko screaming ‘Greed is good!’ in a corner all the time? Those are not primary markets.
Primary markets are where companies issue or sell their shares and debt for the first time. This process is usually called an Initial Public Offer (IPO) where companies with the help of underwriters issue their shares for the first time for people at large to buy, including Institutional Investors and individual investors. The CEO of the company then piles up all that cash, sleeps on top of it and whispers ‘Greed is good’ to himself. Just kidding!!
The company puts the money to use as mentioned in the Prospectus, a detailed boring 300 page document that outlines all of the uses the money would be put to and projected cash-flows to see how the company is planning to earn with that money, along with a ton of self-appraisal of the company’s management (which honestly I don’t see the point of). This document is issued prior to an IPO and is legally binding. So unless mentioned in prospectus, CEO doesn’t pile it up and sleep on it.
Fun fact, this also means that if the company doesn’t put it to use exactly as mentioned on the exact same timeline, the shareholders have the right to file a class-action suit for return of money at the exact same price (as issue per share), which is sort of what almost happened to Sterling and Wilson in January, 2020.
There are, of course, debt primary markets where both companies can offer its bonds and government offers Treasury bills. Another interesting fact, the interest rate on such treasury bills is one of the major rates that guide market’s estimate of minimum return on any investment they make, called market risk-free return.
There are various types of issues in primary markets. The basic idea remains the same as Issues markets mentioned above, but there are slight changes in the process and recipients.
The first is Rights Issue, which is like a Further Public Offering (FPO) but with one difference that the existing shareholders have preferential rights over the issue, which they can either exercise or sell like an option, so someone else can exercise that right. People at large can also buy such shares, but only after the deadline of exercising rights has passed.
Another such issue is Private Placement. This is basically companies offering their shares to banks or hedge funds to raise cash, but this is not accessible by people at large, unless sold on a secondary market.
What is a Secondary Market?
The secondary markets are where majority of buying and selling of such securities happen. Once issued on the primary markets, the secondary markets become listed on popular stock exchanges like New York Stock Exchange (NYSE), Bombay Stock Exchange (BSE) and NASDAQ. The security’s price is determined by the demand and supply chains for the stock which is further determined by company’s performance and general bearish and bullish trends.
Secondary markets are also further classified as follows
1. Auction Market:
The first is the Auction Market. The idea is that all buyers and sellers of securities gather at one place and quote the prices at which they’re buying to sell.
Allow me to paint an image, everyone yelling in a market with one arm up holding cash, and there are huge screens at the centre of the room.
That is an Auction market. Examples include NYSE, BSE, Hong Kong Stock Exchange, etc.
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2. Dealer Market:
The second kind of primary market is the dealer market. Here, the dealer buys or sells the securities from his inventory, to other dealers and other investors. The basic ideology of dealers is to buy and sell the security at cheapest possible rate, in order to incentivize people to buy and sell from that dealer. The dealers make profit from that spread.
There are third and fourth markets as well, but they don’t concern general investors. The basic idea is to buy and sell huge quantities of securities without essential driving up the price of stock because of sudden demand surge, also with minimalist interference.
Primary Market vs. Secondary Markets: Differences
The first major difference lies in their function. Primary markets exist to get shares in the hands of general people, while companies retain the money raised from such sale, where buyers are investors but seller is the company itself. Secondary markets transactions do not concern the company, in the sense that the money generated from sale is in the hands of investors, and buyers are also investors.
As, as logical train dictates, this entails that primary market action happens only once, whereas there is no upper limit to how many secondary transactions can take place. This means that for primary markets, the price is fixed, whereas it keeps fluctuating for secondary markets. The intermediaries in the primary markets are underwriters, whereas secondary market intermediaries include brokers and dealers.
No to miss out, Mark to Market: Meaning, Examples & Advantages
Primary vs Secondary Market:
While primary markets test the viability of the company in the markets, secondary markets test everything from management to practices. As a general investor, an understanding how these markets operate provide a major insight about current trends and nature, which can be the difference between loss and gain.
What do you think? Do share your views on the primary and secondary markets and their functioning in general.