Primary market is a subset of financial market, where surplus funds are invested in new companies. It usually involves first sale of newly issued securities by authorized operators (so called initial public offering - IPO).
Factors influencing decision to invest on primary market
One of the factors influencing the possibility of investing in this market is the tendency to save money. The larger the investors' conviction that the placement of their funds on the primary market is better than in the bank, the more likely it is that this investment will take place. For businesses, selling their issued securities on the primary market represents an opportunity to obtain funds to finance its activities. In effect, the primary market offers opportunities of supplying funds to a business. The players in this market can be both corporations and individuals with a surplus of funds, who are interested in the purchase of issued securities.
To examine the profitability of a proposed issuance of securities on the primary market, it is recommended that the enterprise should firs obtain information about:
- possibility of obtaining a bank loan, and possibly also its cost,
- possible emission price (which may be fixed or variable),
- possible returns from such an emission,
- cost of a given emission.
The types of emissions on the primary market
On the primary market there are two types of securities issuances: public issue and private placement. Public issue of securities is the one in which the offer of acquisition of securities being issued is made through the media. The offer for purchase, however, is addressed to an indefinite number of investors, or at least to more than 300 people. The securities placed on the market must be in a de-materialized form, and the emissions can be made repeatedly by the same issuers. To be able to make its securities publicly traded, the operator must obtain the approval of the Securities and Exchange Commission. The exceptions are the securities issued by the Treasury and the Polish National Bank. Securities, which may be admitted to trading on a public market are shares, bonds, marketable securities law and derivative rights.
In the case of private placement, the offer is addressed to fewer than 300 persons, turnover is of a private character, can take place with the participation of state, or only between private individuals. There is also no need of obtaining the permission of the Securities and Exchange Commission for the issuance of securities in the form of a private placement.
The functions of the primary market
- allocation of capital in the most attractive and efficient sectors of the economy,
- development opportunities for businesses,
- increasing competition in the financial market,
- development of the securities market (new issues, new investors);
- improved valuation of the issuer on the primary market;
Examples of Primary market
- Initial Public Offering (IPO): An Initial Public Offering (IPO) is the process by which a company first issues its shares to the public. It is a way for a business to raise capital to fund its operations and for investors to purchase a stake in the company. Examples of companies that have recently gone public include Lyft, Uber, and Airbnb.
- Secondary Market Offering (SMO): A Secondary Market Offering (SMO) is a sale of existing securities by existing shareholders. This typically occurs when the company has already gone public and the shareholders are looking to sell their shares. One example of an SMO is when an investor purchases shares of a company on the open market.
- Private Placement: A Private Placement is a sale of securities directly to a limited number of qualified investors. The sale is usually done through an investment bank, and the investors are usually large institutional investors such as mutual funds, hedge funds, and pension funds. An example of a private placement would be when an investment bank arranges the sale of company shares to a select group of investors.
- Rights Issue: A Rights Issue is a sale of additional securities to existing shareholders. The company offers existing shareholders the right to purchase new shares at a discounted price. An example of a rights issue would be when a company offers existing shareholders the right to purchase additional shares at a discounted rate.
- Debt Financing: Debt Financing is a form of financing in which a company borrows money from investors and repays it over a period of time with interest. An example of debt financing would be when a company borrows money from a bank or other lender and repays it over a period of time with interest.
Advantages of Primary market
The primary market offers a number of advantages, such as:
- Access to Capital: The primary market helps companies to raise capital through the sale of new securities. Companies can issue stocks and bonds, and investors can buy these securities directly from the issuing company. This provides a source of capital that companies can use to expand their business or pay off existing debt.
- Liquidity: Since the primary market is an open market, it is highly liquid. Investors can easily buy and sell securities, such as stocks and bonds, without any difficulty. They can also trade these securities in real-time, allowing them to take advantage of market opportunities as they arise.
- Price Discovery: The primary market provides a platform for price discovery. Prices of securities are determined by the demand and supply which are influenced by the performance of the company, macroeconomic data, and other factors. This helps investors to make informed decisions about where to invest their money.
- Lower Cost: The primary market is relatively less expensive than the secondary market. Companies do not have to pay brokerage fees for issuing securities, making it an attractive option for raising capital.
- Diversification: The primary market provides access to a wide range of companies and industries. Investors can choose from a range of different types of securities, such as stocks, bonds, and mutual funds. This allows them to diversify their portfolio and invest in a variety of different companies and industries.
Limitations of Primary market
Primary market involves a number of limitations, such as:
- High costs associated with offering new securities, which could be too expensive for some firms;
- Limited options for investors, as the securities offered are usually of a higher risk and not always liquid;
- Difficulty in determining the true value of the securities due to lack of historical data;
- Lack of regulation, which can make it difficult for investors to trust the issuer;
- Long lead-times for the issuance of new securities, which can reduce the potential returns for investors.
Primary market includes many other approaches, such as:
- Private placements, which occur when securities are offered to a limited number of investors, usually large institutional investors, outside of the public market.
- Direct public offerings, which are used to raise capital by selling securities directly to the public.
- Rights issues, which are when a company already listed on a stock exchange offers additional shares to existing shareholders.
- Dutch auctions, which are when a company sets a price range for a security offering and allows investors to bid at any price within the range.
- Secondary market offerings, which are when a company previously listed on a stock exchange offers additional shares to the public.
In summary, primary market includes approaches such as private placements, direct public offerings, rights issues, Dutch auctions, and secondary market offerings. Each approach has its own characteristics and purpose, and can be used for different purposes when it comes to raising capital.
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- Loughran, T., Ritter, J. R., & Rydqvist, K. (1994). Initial public offerings: International insights]. Pacific-Basin Finance Journal, 2(2), 165-199.
- Silber, W. L. (1983). The process of financial innovation. The American Economic Review, 73(2), 89-95.
Author: Anastazja Samarska