The financial market, unlike any other market in the world, provides a platform where new securities are sold to members of the public on a regular basis. A security is a financial instrument that holds a value (in monetary terms) and may be sold. Furthermore, it represents the right to an ownership position in a publicly traded corporation by way of stocks, bonds and options.
Financial products are bought and sold at the capital market and these financial products are broadly classified into the primary and secondary stock market.
A good knowledge of what the primary and secondary market is and how they function is very important for an investor in other for him/her to comprehend the stocks trade. Without the aforementioned knowledge, the stock market would be more problematic to discern and won’t even be as profitable. With this in mind, it is pertinent that before an individual invests his savings in the financial market, he/she must know the difference between the primary and secondary market.
What is the primary market?
The primary market or the new issues market (NIM) is basically where stocks are created. When a company corporation decides to go public for the first time by raising an Initial Public Offering (IPO), it is done in the primary market. Here, the company sells its share to the investors through an investment bank or a finance syndicate of securities dealers known as underwriters. Funds can also be raised by the government and other public sector institutions through the issuing of bonds.
The issues that a corporation makes can also take the form of Bonus issue, right issue, offer for sale, public issue etc.
In the primary market, capital and equity can be generated through any of the following means:
- Preferential allotment: like the name implies, preferential allotment involves allotting securities or shares on a preferential basis. When a company needs to raise fund to settle its debt or expand its existing business, issuing securities to the general public may not always be feasible because it costs a lot of time and money. The company may then decide to sell to a small group of select individuals or companies who are interested, thereby reducing the paperwork and man hour that selling to the public involves.
- Private placement: When a company needs to raise money, they can do it in the private market as opposed to the public market. The private market affords them the advantage of obtaining the fund they need faster and also helps them to avoid certain fees. If they raise the money privately, they can avoid having to register the sureties and also avoid having to file a prospectus. By avoiding the aforementioned, they are able to get capital from investors into the coffers of the company at a much faster rate than would have been possible had it been raised publicly. This is the idea behind private placement. A private placement is therefore a means of raising capital that involves offering up for sale unregistered sureties to a particular number of investors. Warrants otherwise known as bonds and shares of stock of the company are exchanged for cash.
In the United States of America, even though all placements must adhere to the securities act of 1993, the securities that are offered in a private placement do not have to be registered with the Securities and Exchange Commission. However, the issuance of securities must be in line with an exemption from registration as stated in the securities act of 1993.
- Public issue: this basically involves selling securities to the public at large. Issuing stocks publicly allows members of the general public to own a part of the company; however, they won’t be able to own a controlling factor. A public share can be an initial public offer (IPO) or a further public offer (FPO).
- Rights issue: this is an invitation to present shareholders to purchase more shares in a company at a price lower than the market price but on a future date. Here the securities are known as rights. Pending the date for the maturation of the rights, a shareholder can decide to sell his/her right in the same way a person would sell an ordinary share.
What is the secondary market?
The secondary market also known as the Aftermarket is basically where stocks are traded. It is a financial market where financial instruments such as bonds, stocks, options and futures which were issued in the primary market are sold amongst investors. Here an investor buys securities from another investor as opposed to purchasing directly from the issuer.
The secondary market is divided into 2 kinds of market.
- Auction market: this is a centralized and organized exchange where buyers and sellers (or their representatives) meet at a place and announce the rate at which they are willing to sell or buy securities. The buyers and seller “bid” or “ask” prices. Every price is announced publicly and investors who wish to buy shares can easily make their choices. Examples of auction markets include the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) etc.
- Dealer market: in this market, there is no central location for interested parties to meet each other, rather, the buying and selling of securities occurs through telephone, custom order machines, computers etc as opposed to an actual trading floor. The sellers make their offer through the aforementioned electronic methods while dealers then relay the information to the buyers. The dealers earn their profit by selling securities in their inventory. National Association of Securities Dealers Automated Quotations System (NASDAQ) is a good example of the dealers market. Over the counter (OTC) market is a variation of the dealers market.
Differences between the primary and secondary stock market
From what we have discussed above, it is quite obvious that the primary and secondary markets are not the same in any way. The differences between them are as follows:
- In the primary market, the seller of a security is also the issuer of the security while in the secondary market, the seller of the security is the person who holds the security and is willing to offer it up for sale.
- In the primary market, companies are supplied with funds that they need for the settlement of debt and running or improving their businesses, whereas in the secondary market, the companies are not provided with fund.
- Primary issuing of securities is not a constant process and as such it does not occur regularly in the primary market, while secondary issuing of securities occurs on a frequent basis.
- In the primary market, a security can only be sold once by the company but in the secondary market, a security can be sold and resold multiple times.
- Primary securities do not always exist previously in the market until the point of initial public offering. Secondary securities on the other hand are outstanding.
- Buying and selling of shares in the primary market is between a company and the investors while in the secondary market, it is between investors.
- In the event of a change in price, the original issuer (the company) will not be affected in the primary market, while in the secondary market; investors will be affected for the better or worse if the price changes.
- The intermediary that exists in the primary market is the underwriter who then sells to the general public. In the secondary market, brokers act as intermediaries.
- In the primary market, the price of shares are fixed and constant, in the secondary market however, the prices of shares are subject to the laws of demand and supply and as such they have the tendency to fluctuate in price.
- The primary market is not a place per say. That is, it is does not have a specific location while secondary markets has a physical existence.