Primary Market Versus Secondary Market
There has always been a dilemma on which is better, primary or secondary market. Both basically share the same aim, assisting companies obtain capital funding. The major factor that differentiates these is the process used to collect funds.
Primary market is the market where companies issue their new securities for the purpose of attaining capital. Firms and public or government institutions can gather funds from the market by issuing stock and bond in the new issue market. They obtain equity capital via stock issue and debt finance by bond issue. This raising of funds takes places via an IPO (Initial Public Offering). The securities are sold directly to the investor and he is known as a shareholder in this case. In exchange of the funds the investor contributes, he is issued a share certificate that represents the interest he holds in the company. The price of the security is stagnant or on a face value in the primary market. The securities are available only for a short period of time, or the issue window, which are a few days. Here the preference is given to large investors who want to buy more securities in one go. However, a common man can also invest in an IPO as a retail customer.
On the other hand, a secondary market is a market where securities which have already passed through the primary market (or new issue market) and have been issued are traded as instruments. Instruments like stocks, bonds, futures and options are traded here. Once the security is purchased in the primary market and the investor decides to sell it, it appears on the secondary market for other investors to buy. The price of the security may be different from the face value though, which is an effect of the performance of the security in the market. So basically market forces and performance of a company determines the price of share in secondary market.
The secondary market trade happens with the help of stock exchanges like New York Stock Exchange, Bombay Stock Exchange, Shanghai Stock Exchange, etc where the value of the share is affected by the index of that exchange. These stock exchanges can be considered a medium or a platform where the trade takes place. The trade can take place on all working days in the designated functioning time. Anyone can purchase securities in the secondary market. All they have to do is pay for the security that is being traded.
Role of Underwriter in an IPO (Initial Public Offering)
Things may not always go as planned in the primary market though. The issuing company has to reach a certain amount of subscription in order for it to stay in the market. If the subscriptions do not hit that mark then the IPO can get cancelled. To avoid this or ensure there is a back up in case there is under subscription, the issuing company hires an underwriter. The underwriter promises to buy the number of shares needed to hit the minimum subscription after allotment of shares to the investors.
Parties involved in Primary Market
There are many parties involved in the primary market. The issuing company itself is one of them. There is a lead manager on the issue who takes care of the process. The underwriters are the ones who sign an agreement with the company. They can be one or more. Then there are the bankers to the issue who manage the inflow of the capital, i.e. manage the funds on behalf of the company. In Indian context, Registrar to the issue is appointed by SEBI (Securities and Exchange Board of India) who performs the functions connected to the allotment of the shares. The advertising agency hired also plays an important role by getting the word out to potential investors. The final party is the investor himself.
Parties involved in Secondary Market
In the secondary market, things are a bit different. There aren’t as many parties involved. The Stock Exchange is the source of the trade. That is where the shares are quoted and can be bought and sold. The second party is the broker. He is the intermediary that facilitates the buying and selling of shares. This is done on a commission basis. A fee or a commission is charged by the broker for every sell or buy of shares. The final party again is the investor. He is the one disposing off his investment for money or buying shares to invest.
Key difference between primary and secondary market
There are reasons investors are attracted to a particular market, they have their own pros and cons. Where on one hand in the primary market, you may get decent profit in terms of listing gains (if you buy during the subscription offer and sell it when the company is listed on exchange), on the other hand in secondary market the returns are the gains made by trading the shares. The primary issues are infrequent, where as in the secondary market trade is very frequent. And most important, there cannot be a secondary market without existence of a primary market and therefore both are very important for financial markets.
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