What are Primary Markets and Secondary Markets?

Great job on grasping the ecosystem of financial markets! Now, let us look at something more intriguing. Have you ever wondered how companies like your favourite sneaker brand raise the cash to create those must-have kicks? Or how do governments fund those shiny new roads? The answer lies within the financial markets itself! We've just explored the bustling ecosystem – a network of banks, investors, and other players working together. But where does the actual buying and selling of these financial tools, like stocks and bonds, take place?

Capital Markets can be classified as Primary Markets and Secondary Markets. You can look at the primary market as the grand debut of a blockbuster movie. It’s where companies raise capital by issuing new securities, similar to a movie premiere, where tickets are sold for the first time. Investors get a chance to be part of the initial excitement, funding innovations and expansions. Now, consider the secondary market as the busy movie theatres showing blockbusters repeatedly. This is where investors buy and sell previously issued securities, providing liquidity and ongoing price discovery. Both markets are important: the primary market fuels economic growth by injecting fresh capital, while the secondary market ensures assets remain liquid and investments can be traded easily. Let’s understand this better!

What are Primary Markets?

A primary market is where new securities are issued and traded for the first time. Companies, governments, and other entities raise capital by issuing stocks, bonds, or other securities. Issuers can raise funds directly from investors by offering securities to the general public or a select group of them. Securities in the primary market are priced based on market conditions and demand. Different types of issues in primary markets are as follows:

1. Public Issue:

• Initial Public Offer (IPO): This is when a company offers its shares to the public for the first time. It's a major milestone for any business, allowing it to raise substantial capital by selling ownership stakes to a wide range of investors.

• Follow on Public Offer (FPO): Unlike an IPO, an FPO is when an already listed company issues additional shares to the public. This helps the company raise more capital after the initial offering.

2. Preferential Issue: In this type, shares are issued to a select group of investors, usually at a price not related to the current market price. This method is often used to quickly raise funds from investors deemed strategic for the company’s growth.

3. Rights Issue: Existing shareholders are given the right to purchase additional shares at a discounted price proportional to their current holdings. This allows loyal investors to maintain their ownership percentage while the company raises new funds.

4. Bonus Issue: Instead of raising new funds, companies issue additional shares to existing shareholders free of cost, based on the number of shares already owned. This is often done to distribute accumulated profits and can be a sign of the company's healthy financial status.

Process of Issuing Securities

In order to raise funds from the public, companies must file an offer document with SEBI known as the draft red herring prospectus or the draft prospectus. The prospectus contains information such as the company's history, the promoters' details, the business model, the company's financial history, the risks in that business, the purpose for which the money is being raised, the terms of issue, and other information that will assist an investor in making an informed decision about investing in its shares. Securities issued in the primary market are listed on a recognized stock exchange within six (6) working days of the issue's closing date. The shares are then listed on recognized stock exchanges for further trading. The shares allotted by the company are credited to the investor's Demat account, which is maintained with a Depository via a SEBI registered Depository Participant (DP). An investor can sell their shares on the stock exchanges through a SEBI-registered stock broker and receive payment.

What are Secondary Markets?

While the primary market is where new securities are issued, the secondary market is where these securities are actively traded among investors. This market deals with a wide range of financial instruments, including stocks, bonds, and derivatives (contracts based on the value of underlying assets). The key functions of the secondary market include providing liquidity, allowing investors to buy and sell securities without significant price changes quickly, and enabling continuous price discovery through supply and demand interactions. In addition, it allows investors to adjust their portfolios and manage their risk exposure. By facilitating the seamless transfer of ownership, the secondary market ensures that investments remain liquid, offering flexibility to investors and stability to the financial system. This ongoing trading activity helps in maintaining maintain a vibrant and efficient market environment, which is necessary for economic growth and investor confidence.

Interrelation between Primary and Secondary Markets

Primary and secondary markets are intrinsically linked, with each playing a vital role in the financial ecosystem. The primary market allows companies to raise new capital by issuing securities, providing the initial funds necessary for growth and expansion. Once these securities are issued, they enter the secondary market, where they are actively traded among investors. This ongoing trading ensures liquidity, making it easy for investors to buy and sell securities, thus maintaining their value. The existence of a vibrant secondary market reassures issuers in the primary market that there will be a continuous demand for their securities, thereby facilitating future capital raises and supporting long-term economic stability and growth.

Conclusion

Now that you understand how primary and secondary markets operate, you can see their importance in maintaining a vibrant financial ecosystem. They provide the necessary channels for capital flow and liquidity. But our journey doesn’t end here. In our next chapter, we’ll look further into the ecosystem of financial markets, equipping you with the knowledge and confidence to make better financial decisions.

Happy Learning!