A capital market, where governments and other institutions raise long term funds, is divided into 2 markets: A primary market and a secondary market. A primary market is where new securities are issued for the first time and a secondary market is where previously issued shares are traded. The primary market can also be referred to as a New Issue Market (NIM). Examples of securities issued in the primary market are government bonds, corporate bonds, preference and ordinary shares. The primary market plays an important role in injecting capital into the economy. The major feature of the primary market include fresh capital, strict regulations for issuing new securities and a direct flow of funds from investors to issuing companies. This article outlines the primary market features.
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New Capital is Issued
A primary market is where new capital is raised for long term use. This is an important feature of the primary market. The new capital is obtained through;
When a private firm decides to go public in order to raise capital for various reasons it can do this through an (IPO), an initial public offering. This means that the company will sell its securities to the general public and allow those securities to trade freely on the securities market. Investment bankers usually market these public issues. They also advise the firm on the terms regarding issuing the securities. The issuing firm files a prospectus stating the company’s future outlook in addition to the issue with the Security’s Exchange Commission (SEC). Once the SEC approves, the price at which the securities will be sold to the public is announced. Usually, the underwriters or investment bankers buy the securities from the issuing firm to resell to the public. However, these securities are bought by the underwriter at a discount and not the public offering price. The discount serves as compensation to the investment bankers, a procedure known as ‘firm commitment’. Sometimes the underwriters may obtain other securities from the issuing company. Once the process is complete the firm’s securities will be listed on the stock exchange for the first time. Ordinary shares are issued via IPOs and they are an example of capital market instruments. So initial public offerings are a feature of the primary market.
Rights issues are a feature of the primary market. Rights issue is when companies offer new shares to existing shareholders according to the proportion of their shareholdings so as to raise new capital. A further public offering, (FPO) is a process where companies that are already listed on the stock exchange issue new shares in order to obtain additional funds. Normally, these shares are issued to existing shareholders at a discount for a limited period of time. A ‘seasoned equity offering’ is another name for additional shares issued by companies that are already listed. Also, companies are allowed to register new shares and gradually sell them to the public. This allows companies to sell on short notice or in small amounts without incurring extra costs. The securities are said to be on the shelf which gave rise to the term shelf registration.
Preferential allotments are also a feature of the primary market. A listed company can issue shares to few individuals at a price that may or may not be related the current market share price.
This occurs when a private firm sells shares to a small number of wealthy investors. An organisation can offer bonds, shares or any other securities to a small group of institutional investors. Private placements are easier to issue. They are less costly because there is no need to prepare extensive registration statements like a public company. In fact, the company remains private. Companies that are still in their early stage normally issue these to Investment banks, high net individuals or hedge funds to raise capital. The downside of private placements is that the share price investors pay for the shares is low. This is because private placement shares cannot trade on the secondary market, they are sold only in the primary market. As a result, investors demand price reductions since the shares are regarded illiquid. Private placements are one of the primary market features.
Qualified Institutional Placement
This is another kind of private placement, where a listed company issues securities in the form of ordinary shares, partly or wholly convertible preference shares or debentures. These shares are bought by qualified institutional buyers who consist of foreign institutional investors, mutual funds, Insurers and public financial Institutions among others. Issuing qualified institutional placements is simpler in that, they do not attract standard procedural regulations.
Organisations Directly Deal with Investors
Another feature of primary markets is that companies work directly with investors unlike in the secondary market where the company is indirectly involved. In a primary market, companies benefit directly from the capital injected by investors.
Strict Regulatory Requirements
A private company can only have its shares listed on the securities exchange if it meets the minimum regulatory requirement of a stock exchange. The legal and regulatory requirements differ from country to country. Strict regulatory requirements are an important feature of the primary market.
3 main players (Investors, Underwriters and the Organisation in need of Capital)
The primary market has 3 main players who are the Investors, (lenders) who purchase the new securities, the organisation (the borrower) and underwriters the (intermediaries). The role of an underwriter is essential in the primary market. Underwriters can be banks or any financial institution that pledges to buy all unsold shares of the issuing company. Underwriting is also one one of the functions of merchant banks. Their role is to assess and take up the risk of the new shares for a fee.
Differences Between A Primary Market and Secondary Market
Both the primary market and the secondary markets play a major role in financial markets. A secondary market cannot exist without the primary market. As much as both markets are related there are key differences. These differences will also help understand the features of the primary market.
|Features of Primary Market
|Features of Secondary Market
|· New Issue Market
· Direct (organisations benefit from investors’ purchases)
· Funds are channelled directly to start-ups and previously listed companies)
· A security can only be sold once
· The intermediaries in the primary market are underwriters
· Price for new issues is fixed
· The market is not in any specific spot
· Bulk buying of securities is rare
· Liquidity is provided to issuing organisations
|· After Market
· Indirect (trading previously issued shares benefits investors)
· Funds circulate amongst investors and speculators
· A security can be sold any number of times
· The intermediaries in the secondary market are brokers
· Prices fluctuate on the secondary market
· Trading takes place on the stock exchange
· Bulk buying of securities is common
· Provides liquidity to investors
· Price discovery (the price of security is determined in the secondary market)