Primary and secondary market
| Primary and secondary market |
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A primary market is a market where new assets or securities are issued, and investors purchase them directly from the issuer. These securities are typically bought and sold through an investment bank or brokerage firm. The proceeds from the sale of these securities are used to acquire capital for the issuer.
A secondary market is a market where investors can buy and sell existing securities from other investors, as opposed to directly from the issuer. This market is facilitated by a stock exchange, where buyers and sellers can match up and trade securities. The prices of securities in the secondary market are determined by supply and demand.
Example of primary and secondary market
- Primary Market: The initial public offering (IPO) of a company is a form of primary market transaction. In an IPO, a company issues new shares of stock to the public for the first time. IPO proceeds are used to fund the company's operations, acquisitions, or other investments.
- Secondary Market: The New York Stock Exchange (NYSE) is an example of a secondary market. On the NYSE, investors can buy and sell existing shares of stock from other investors. The prices of these stocks are determined by the market supply and demand.
Types of markets
Primary markets and secondary markets are two distinct types of financial markets. The primary market is where new securities are issued and sold to investors for the first time, while the secondary market is where existing securities are bought and sold between investors. The following are the different types of primary and secondary markets:
- Primary Markets: Primary markets are where new securities are issued and sold to investors. Examples include the New York Stock Exchange, the National Association of Securities Dealers (NASDAQ), and the American Stock Exchange (AMEX).
- Secondary Markets: Secondary markets are where existing securities are bought and sold between investors. Examples include over-the-counter markets and regional stock exchanges.
- Derivatives Markets: Derivatives markets are where derivatives, such as futures and options, are traded. Examples include the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME).
- Foreign Exchange Markets: Foreign exchange markets are where currencies are traded in the form of currency pairs. Examples include the London Stock Exchange and the New York Stock Exchange.
- Commodity Markets: Commodity markets are where commodities, such as gold, oil, and wheat, are traded. Examples include the London Metal Exchange and the Chicago Board of Trade.
Advantages of primary and secondary market
The advantages of primary and secondary markets are numerous. Here are some of the most notable advantages:
- Primary markets provide a direct source of capital to issuers, enabling them to acquire the funds necessary to finance their operations. This capital can be used to expand their businesses, research and develop new products and services, and invest in new ventures.
- Secondary markets provide liquidity to investors, allowing them to quickly and easily buy and sell securities. This greater liquidity can lead to more efficient pricing and better returns on investments.
- Primary markets offer greater control to issuers, as they are able to set the terms and conditions of their securities. This allows them to tailor their securities to their specific needs and objectives.
- Secondary markets offer greater diversification opportunities, allowing investors to access a variety of securities from different issuers. This can help reduce risk and provide a greater potential for returns.
Limitations of primary and secondary market
The primary and secondary markets both have their own limitations.
- The primary market is limited in that it is only open to select investors, such as institutional investors, who must meet certain criteria in order to participate.
- The secondary market is limited by liquidity, meaning that the supply and demand of the security can cause prices to fluctuate significantly.
- The primary market is subject to price manipulation as the issuer of the security has control over the pricing.
- The secondary market is limited in that there is a lack of transparency as to who is trading and how much is being traded.
- The primary market is also limited by the fact that it is difficult to accurately value the security before it is issued, making it difficult for investors to assess the risk.
- The secondary market is limited by restrictions placed on certain securities, such as insider trading rules, which can limit the ability of some investors to buy or sell certain securities.
- In the primary market, there is a higher degree of risk as the issuer is primarily responsible for the accuracy of the information provided to investors.
- In the secondary market, there is a lack of direct communication between the issuer and the investor, making it difficult to accurately assess the true value of the security.
Suggested literature
- Goldstein, M. A., Hotchkiss, E. S., & Pedersen, D. J. (2019). Secondary market liquidity and primary market pricing of corporate bonds. Journal of Risk and Financial Management, 12(2), 86.
- Pennington-Cross, A. (2002). Subprime lending in the primary and secondary markets. Journal of housing research, 31-50.
