Primary vs. Secondary Capital Markets: An Overview
The term capital market refers to any part of the financial system that raises capital from bonds, shares, and other investments. New stocks and bonds are created and sold to investors in the primary capital market, while securities are traded by investors on the secondary capital market.
Primary Capital Markets
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 until 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.
Secondary Capital Markets
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 December 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 has two different categories: the auction and the dealer markets. The auction market is home to the open outcry system where buyers and sellers congregate in one location and announce the prices at which they are willing to buy and sell their securities. The NYSE is one such example. In dealer markets, though, people trade through electronic networks. Most small investors trade through dealer markets.
[Important: There are as many secondary markets as there are financial products, so stocks will be available on stock markets and mortgages will be repackaged and sold to investors.]
- The new issue of stocks and bonds such as IPOs are issued on the primary capital market.
- Companies that wish to raise equity will offer securities to large investors on the primary market at a set price.
- Once a security has traded on the primary market, it will then open up for trade to smaller investors on the secondary market.
- Stock exchanges like the NYSE, LSE, and Nasdaq are secondary markets.