Primary Market and Secondary MarketDifferences You Need to Know Between the Two!

Written By:
Lisa Borga

Reviewed By:
FundsNet Staff

It is likely that all investors have heard the term “market” used at some point, and this word can have a lot of meanings, particularly in terms of financial investment.

In this context, it is most often used in broad terms to describe both the primary and secondary market for securities.

Though both of these markets offer an investor a broad array of securities, there is a significant difference between the two.

The primary market is where securities are first introduced and sold to investors.

In contrast, the secondary market is where securities are traded amongst investors.

Though the primary and secondary markets are often left undistinguished for casual purposes, it is important for investors to understand the difference between these markets.

These markets both offer unique benefits and investment opportunities to investors.

What Is the Primary Market?

The primary market is the market in which securities are created.

This is where companies first offer newly created stocks and bonds to investors, generally through an initial public offering (IPO).

In this case, the company making the IPO will be referred to as the issuer, and they will work through investment banks that underwrite the issuance of shares to be sold to investors.

Capital raised through an IPO will then become the issuing company’s equity capital.

Similarly, companies and government entities will offer other types of securities, such as bonds and debentures, on the primary market in order to raise capital.

Often this will involve several underwriting firms that will determine the financial details of the offering, such as the issuing price of the stock that will then be sold directly to investors.

Generally, only large investors or those interested in purchasing a large number of securities will take part in sales made in the primary market.

This is because the issuers and underwriters bringing the security to market are typically only interested in selling a large number of securities at once.

The defining feature of the primary market is that this is where securities are first introduced, and the proceeds will directly benefit the issuers.

This is the first opportunity for companies to raise capital from the public as well as for investors to purchase shares in an enterprise.

Different Types of Primary Offerings

Offering securities on the primary market offers companies the opportunity to raise capital, and there are a few different ways that this can be accomplished, including, most notably, public issues, rights issues, private placement, and preferential allotment.

Which option a company chooses will generally depend on what stage a company is in, and its needs.

The most common example of a primary market offering is a public issue.

With this, a company uses an IPO to list its securities on a stock exchange.

However, for companies that have already issued securities that have entered the secondary market, it is possible to raise additional equity through a rights issue.

In rights, existing shareholders are offered a discounted price based on their existing shares.

This allows a company to raise additional money from existing equity holders.

A private placement is another way to raise money from current equity holders through making an offer to sell directly to certain major investors, often banks or hedge funds, instead of making a public offering.

Similarly to a private placement, in a preferential allotment, a company offers certain investors the opportunity to purchase shares at a discounted price that would not be available to the general public.

Another option for both businesses and governments to raise capital is by offering short or long-term bonds on the primary market.

These bonds are used by firms to raise capital and offer investors coupon rates that will match the interest rates at the time they are issued.

This may be higher or lower than the interest rates of existing bonds available on the secondary market at the time they are issued.

The Secondary Market

The secondary market for equities is most often referred to as the stock market.

This includes the New York Stock Exchange, NASDAQ, S&P 500, and all of the other major stock exchanges worldwide.

The secondary market is defined by investors trading securities amongst themselves without the involvement of the companies that issued them.

In the secondary market, an individual may purchase shares in a company without the involvement of the issuing company.

As an example, if you buy Walmart stock in the secondary market, you buy the stock from another investor without Walmart being directly involved.

Secondary markets may also allow investors to profit from their investments sooner than they otherwise would.

For instance, if an investor has a bond, it will pay the full par value when it reaches maturity, but it could be years away.

However, the investor could instead choose to sell it on the secondary market and possibly earn a nice profit if interest rates have declined since the bond was issued.

These two specialized categories are in the secondary market. They are:

Auction Market

An auction market involves having those institutions and individuals who are interested in trading securities gather together and state what prices they are willing to buy or sell at.

These prices are called the ask and bid prices. The concept behind this is that if all interested parties are brought together and announce their prices, it should result in an efficient market.

Therefore, in theory, it should be unnecessary to look for the best price since having all the buyers and sellers together should result in prices that all parties find acceptable.

The New York Stock Exchange is a good example of an auction market.

Dealer Market

Another type of specialized market is a dealer market.

In a dealer market, the interested parties do not need to gather together in a specific location.

Instead, the parties gather together through electronic networks such as NASDAQ, which is the most well-known dealer market.

In a dealer market, securities are listed by dealers for purchase or sale at specific prices that they are willing to accept, and trades can happen at a moment’s notice.

Dealers will then earn profits based on the spread between the prices at which securities are bought and sold.

In dealer markets, the complete transparency of prices creates strong competition between dealers.

This competition between dealers, in turn, acts to provide investors with the lowest possible prices for securities.

Over-the-Counter Market

The over-the-counter (OTC) market is essentially another term often used to refer to the dealer market.

As the name references, an OTC market consists of securities that are not listed on an exchange. The term originally referred to a virtually unregulated system in which stocks were not sold in a physical location but through dealer networks.

This likely originated from the period before the Great Depression in which stocks would sometimes be sold over the counter in shops which also meant that the stocks were not listed in an exchange.

However, as time passed, the OTC market changed, and with the introduction of NASDAQ by the National Association of Securities Dealers, the meaning of the OTC market became less clear. NASDAQ was created in order to create greater liquidity for companies trading through dealer networks and, in turn, introduced many new regulations for how the market would function.

Now the OTC market primarily refers to stocks that are not traded through major exchanges such as NASDAQ or the New York Stock Exchange.

Instead, OTC stocks are traded on the over-the-counter bulletin board (OTCBB) or pink sheets. When stocks are traded through these means, there are far fewer regulations than when trading on one of the major exchanges.

The majority of stocks that trade this way are for small companies and have not undergone the level of scrutiny that a company listed on an exchange would.

These stocks often offer quite a bit of value, but the risk attached to them is far higher.

The Third and Fourth Markets

It is possible that some investors may have heard of “third” and “fourth” markets, and though the majority of investors will likely never have to be concerned with these markets, it is best to be aware of what they are.

These markets deal with large volume transactions between broker-dealers and large institutions.

The third market is composed of OTC transactions performed between broker-dealers and major institutions.

The fourth market similarly is composed solely of deals between major institutions.

The reason for these transactions taking place off of the major exchanges is to avoid the significant costs associated with these public transactions.

However, due to the limited access the public has to these markets, they have little impact on the typical investor.

The Differences Between the Primary and Secondary Market

In practice, the primary and secondary markets can be easy to confuse.

However, there are several key differences, including:

• Introduction to the Market: In the primary market, shares are first created and introduced to the market. In the secondary market, existing shares are traded between investors.
• Relation to the Issuer: In the primary market, sales of securities directly benefit the issuer. However, in the secondary market, proceeds from the sale of securities only benefit the investors trading them.
• Pricing of Securities: In the primary market, securities are sold at fixed prices, whereas in the secondary market, pricing fluctuates based on a number of market factors.
• Related Parties: In the primary market, investment banks will often serve as a crucial intermediary to underwrite the offering of securities. This is not needed in the secondary market, and instead, brokers will serve as an intermediary to connect buyers and sellers.
• Number of Sales: On the primary market, a security can only be sold once. However, on the secondary market, a security can be sold any number of times.

Conclusion

Though in many cases, investors will only be concerned with a limited scope of the market securities, it is important to have an understanding of the market and its structure.

This will provide a strong basis for understanding all of the investment options available to a given investor.

Both the primary market and secondary markets play a major role in how money moves between parties in an economy.

In the primary market, investors purchase securities directly from the company issuing them.

In contrast, investors trade with other investors for securities on the secondary market.

Both of these markets offer numerous distinct options within them to investors, and a strong understanding of these markets can help to diversify investments and build a secure portfolio.

Key Takeaways

• The primary market is where securities are first created. This is where new stocks and bonds are first offered to the public.
• The secondary market is where existing stocks and bonds are traded between investors.
• In the primary market, the sale of securities directly benefits the companies and, in some cases, government entities that offer them. In contrast, proceeds from the sale of securities on the secondary market will benefit the investors that are trading them.
• The secondary market essentially refers to the stock market, and examples of the secondary market include the New York Stock Exchange, NASDAQ, and all other major exchanges.