What are “Primary and Secondary Markets”?
Usually, when talking about the “market”, investors do not specify which market they mean, but rather use the word as a broader term. However, there is a distinct difference between the primary and secondary markets. In the first instance, when companies or sovereign governments want to raise funds, they issue securities such as stocks or bonds for the first time. It is primarily targeted at large institutional investors and is difficult for individual investors to get access to. The secondary market is where the trading activities take place and investors can purchase or sell securities from/to other investors. It is also important as it can give an indication of the health of the broader economy.
Key Learning Points
- The capital markets are split between primary and secondary markets
- The primary market typically involves a company or government, seeking to raise money through issuing new securities on the market for the first time
- The primary market is where securities are created
- The secondary market is where investors trade already available securities between each other
- The secondary market is an indicator of economic conditions
- Individual investors usually have restricted access to primary markets since typical market participants are large institutions
The primary market is the source of newly created issues that have not been traded yet. When a company or government needs to raise funds for its operations, expansion plans or policies, they can issue securities to the market, most often in the form of shares or bonds. In the primary market, the new securities are purchased directly from the issuer.
Issuers will use the services of underwriters to advise and help them with the process around the initial public offering (or IPO). These advisers are usually large investment banks that utilize their brand and connections to attract capital and secure buyers for the newly created securities from other institutional investors. Price volatility is often higher in primary markets as it is difficult to predict future demand, but the underwriters can use short-term price stabilization mechanisms to efficiently manage the risk.
As sovereign bonds do not trade on a centralized exchange, they are usually offered at auctions organized by the state. For example, in the UK the Debt Management Office (or DMO) administers the primary market for new gilt issues.
Small or individual investors typically have restricted access to IPOs as new shares are first offered to large institutions. However, one of the approaches that provide individual investors with exposure to IPOs is investing in a collective investment scheme (usually mutual fund or investment trust) that takes part in the offering.
The secondary market is where the trading activity takes place. Buyers and sellers can trade stocks and other securities with each other but the underlying company is not involved. Secondary markets include the NYSE (New York Stock Exchange), LSE (London Stock Exchange) and the NASDAQ. These trades facilitated by stock exchanges for equity and fixed income securities are traded over the counter (OTC). Many investors believe in the predictive powers of secondary markets as an indicator for the economic cycle – rise or decline in stock prices indicates a boom or recession.
Secondary markets can also help drive share prices towards their intrinsic value through supply and demand, promoting economic and market efficiency. Most of the secondary markets are fairly liquid in normal market conditions so investors could buy and sell securities at almost any point, making them attractive for individual investors.