Difference Between Primary Market and Secondary Market
In a primary market, new shares and bonds are offered to the public for the first time via an initial public offering (IPO). The secondary market, on the contrary, refers to exchanges such as BSE or New York Stock Exchange or NASDAQ where stocks are traded.
A company may have different types of capital requirements depending on its present stage of growth. A well-established company may not require long-term capital. In that case, they may opt for equity financing i.e. raising capital via the sale of shares. But another company, which has a proven track record and now wishes to expand operations may go for an IPO. While equity financing is a secondary market operation, launching an IPO happens in the primary market.
Let’s understand the features of the primary and secondary markets.
What is Primary Market?
Securities are developed in the primary market. Here, firms sell new bonds and stocks to the public for the first time. If you want a clear understanding of the primary and secondary market, you should take into account proper examples.
One key example of a primary market is an initial public offering. These trades allow investors to purchase securities from the bank, which has done the first underwriting for the stock. An IPO will take place as a private company issues stocks to the public for the first time.
nderwriters are responsible for specifying the issue price of the stock. It will enable the investors to purchase the IPO at this price straight from the issuing company. As a result, investors get the first opportunity to provide capital support to the company by purchasing a stock.
Types of Primary Market Offerings
A rights offering issue allows companies to generate extra equity from the primary market only after securities have entered the secondary market. The present investors have access to prorated rights according to the ownership of their shares. Others are allowed to invest in new shares.
In addition to public offerings, companies can also raise capital through private placements and preferential allotments. In a private placement, shares are sold to large investors without being made available to the general public. Preferential allotments involve offering shares to chosen investors, such as mutual funds, banks, and hedge funds, at a special price not accessible to the broader market
Entities seeking debt financing can issue new bonds on the primary market. Newly issued bonds have coupon rates that reflect the prevailing interest rates at the time of issuance, which may differ from the rates on existing bonds.
What is Secondary Market?
Understanding the difference between primary market and secondary market requires having an overview of the two types of markets separately. Now that you have a basic idea of the primary market, let's dig deeper into the concept of the secondary market.
The secondary market is primarily the stock market meant for purchasing equities. It covers all major exchanges from all over the globe. A key characteristic of this place is that investors are known to trade among themselves. Therefore, investors are found trading previously issued securities without the issuing company getting involved in the trade.
The secondary market can be categorized into two groups:
Auction Markets
An auction market is a location where buyers and sellers of securities congregate to declare their willingness to trade. Buyers state their bid prices, while sellers state their ask prices. The objective is to achieve an efficient market where parties can openly declare their prices
In theory, the best price for goods doesn't need to be searched for since the convergence of buyers and sellers results in mutually agreeable prices. The New York Stock Exchange exemplifies an auction market.
Dealer Markets
Unlike a central marketplace, a dealer market allows participants to connect through electronic networks. Dealers maintain a stock of securities and are prepared to buy or sell with market participants. They gain from the difference between the buying and selling prices of securities.
A well-known illustration of a dealer market is the Nasdaq. Dealers, referred to as market makers, offer fixed bids and ask rates at which they are ready to buy or sell a security. The rationale is that competition among dealers will secure the most favorable prices for investors.
Features of Primary Market
- A company turns to the primary market for its long term capital needs. Fulfilling the need for long term capital is, therefore, a feature of a primary market.
- A fresh issue of securities takes place in the primary market. The buyers are usually institutional investors and retail investors.
Features of Secondary Market
- The secondary market helps companies fulfil short-term liquidity requirements. It facilitates the marketability of existing securities.
- It also ensures true and fair dealing for the protection of the investor’s interest.
Primary Market vs Secondary Market
- Securities that are issued in a market are referred to as the primary market. When the company gets listed on an exchange and its stocks are then traded among investors, it is called the secondary market.
- The primary market is also known as a ‘new issue market’ and the secondary market is known as an ‘after issue market.’ Depending upon the demand and supply of the securities traded the prices in the secondary market vary. But, the prices in the primary market are fixed.
- In the primary market, investors have an option to purchase the shares directly from the company, whereas in the secondary market, the investors buy and sell the securities among themselves.
- Investment bankers do the selling in a primary market. In the secondary market, the broker acts as an intermediary while the trading is done.
- In the primary market, the company stands to gain from the sale of a security. While in the secondary market, investors stand to gain any sort of capital appreciation from the securities.
- The securities in the primary market can only be sold once, while in the secondary market sale and purchase is a continuous process.
- The amount that is received from the securities becomes capital for a company whereas; in the case of the secondary market, the same reflects the income for investors.
Difference Between Primary Market and Secondary Market
Once you understand what is primary market and secondary market, go through this table depicting their differences for deeper knowledge:
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The two financial markets -- primary market and secondary market, play a major role in the mobilization of money and help develop the economy. Countries with robust financial markets make it easier for companies to access funds and grow faster.
The process to buy equity in the secondary market is fairly simple. The following procedure is followed while buying or selling shares in the secondary market:
- Open Demat Account with a depository participant (DP) like IIFL.
- Open a trading account with a broker.
- Link your bank account with Demat account and Trading Account.
- The broker buys or sells the shares by executing orders on the electronic terminal
- A contract note is issued by the broker detailing the value of shares purchased plus his brokerage cost.
- The broker collects shares via the settlement process (T+1) and makes payment on the behalf of the investor.
- Order gets executed on the final settlement date (T+2).
Conclusion
The basic difference between the primary and secondary market lies in the type of companies and investors. Companies looking for long term investments for an IPO which is a function of the primary markets, while companies that look for short-term capital use the secondary market.