Difference Between Primary Market and Secondary Market
Primary market and secondary market are part of the capital market. While new securities are issued for the first time in the primary market, secondary markets allow trading of the existing securities. For small scale investors, the secondary market is the right fit whereas huge market players deal with securities in the primary market.
In this article, you will learn about the difference between primary market and secondary market. We will look at these two markets, their functions, and how they benefit investors and traders. You will also learn what securities they trade in.
Table of Contents
- Difference between primary market and secondary market
- What is primary market?
- What is secondary market?
Difference between Primary Market and Secondary Market
Following are the major differences between primary market and secondary market:
Parameter | Primary Market | Secondary Market |
Purpose | Issue of new shares | Already issued securities are traded |
Financing to company | Yes | No |
Trading Frequency | Limited | High |
Products | IPO and FPO | Shares, debentures, warrants, derivatives, etc. |
Types of investors | Investment bankers, financial institutions, companies | Individuals |
Type of Purchasing | Directly from issuer | Through investors that hold the security |
Intermediaries involved | Underwriters | Brokers |
Price Levels | Fixed | Fluctuates with demand and supply |
Beneficiary | Issuer | Investor |
Disadvantage | Time-consuming | Risk prone |
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What is Primary Market?
Companies often have limited funds to fund their business operations and projects for the long term. Due to this, they step into the primary market to raise capital from the public by issuing their shares for the first time. The primary market is a part of the capital market where the issue and sale of securities take place. Buyers can directly purchase securities from the issuer. In this market, the proceeds of the purchase directly go to the issuer.
Companies, governments, and other organizations trade to gather funds through equity-based and debt-based securities. For the first time, stocks and bonds are created for the public in this financial market. Due to this, this market is also known as the âNew Issue Marketâ. Companies issue new issues of common and preferred stocks, notes, bills, and government bonds. Issues in this market are governed by strict regulations of authorities like SEC and SEBI.
How does primary market work?
Primary market works in the following step:
- Company prepares offer documents through SEBI registered merchant bankers. The offer contains information about company, promoters, financial details, terms of issues and disclosures for investors. Draft offer document is filed with SEBI along with status of processing. Company also makes a public announcement about this filing. SEBI reviews the draft document and provides observations on it. These observations are forwarded to the merchant banker who files the final offer document with SEBI after making necessary changes.
- After the completion of legal formalities. The issuer company publishes advertisements informing the public that the issue is open to subscription. Interested investors apply for the shares by filing the form and making payment. Only one application on a PAN is allowed. The Registrar to the issue (RTI) handles the processing of application forms and payments.
- The issue is closed and shares are allotted to applicants either on a lottery basis or proportionally. RTI and merchant bankers together finalise the basis of allotment. Stock exchange officials approve these details and make it available on the website of RTI. Issuer company publishes advertisements about the basis of allotment and issue price. Investors receive the demat credit within 12 days upon allotment. Shares of the issuer company are listed on stock exchange within 12 days of close of issue. After this, the shares are available in the secondary market.
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Types of Issues in Primary Market
Following issues are available in the primary market:
- Public issue: The company issues its shares to the public through an issue of offer document. IPO and FPO are two types of public issue. When the company makes a public issue for the first time, it is called an Initial Public Offering (IPO). If the company makes another public issue for raising capital, it is known as further public offer (FPO).
- Issue of Indian Depository Receipts (IDR): Foreign companies listed in the stock exchange abroad raise money from India investors by issuing shares. These shares are held in a foreign custodian bank. Against this, custodian banks issue IDR which is an instrument that entitles holders to rights of ownership and receiving dividend.
- Offer for Sale: Institutional investors invest in unlisted companies at an early stage. When this company becomes large, investors sell these shares through an issue of offer documents. The shares of the company are listed in stock exchange and proceeds of sale go to existing investors. This is known as an offer of sale.
- Rights Issue (RI): When a company raises issues from existing shareholders by selling new shares, it is known as ârights issueâ. The offer document for rights issue is known as âLetter of Offerâ. Rights issues are kept open for 30-60 days.
- Bonus issue: Existing shareholders are not required to pay any money for receiving these new shares. These shares are issued out of companyâs reserves. After the bonus issue, the equity capital of the company increases but its reserves decrease correspondingly. However the net worth remains the same.
Why is Trading Conducted in Primary Market?
Here are the reasons why people trade in the primary market:
- Initial Investment Opportunity: The primary market offers investors the first chance to buy a new security issuance, often at a predetermined price, before itâs available in the secondary market.
- Potential for Higher Returns: Securities in the primary market might be priced attractively, and investors may anticipate a price surge once the securities are available for trading in the secondary market.
- Direct Purchase from Issuer: In the primary market, investors buy securities directly from the issuer, eliminating intermediaries and associated fees.
- Capital Raising for Companies: Companies use the primary market to raise capital for business expansion, debt repayment, or other operational needs.
- Known Quantity: The number of shares or bonds being issued and their pricing are known in advance, giving clarity to investors.
- Supporting Growth: By participating in the primary market, investors can support the growth and expansion plans of a company they believe in.
- Unique Offerings: The primary market sometimes offers unique financial instruments that might not be readily available in the secondary market.
- Regulatory Oversight: New issuances in the primary market are typically subject to rigorous regulatory scrutiny, which can provide a level of assurance to investors regarding the authenticity and transparency of the offering.
- Preference for Early Investors: Some offerings might provide benefits or discounts to early investors or those who commit a significant amount.
- Diversification: New issuances can offer investors an opportunity to diversify their portfolio with securities not previously available in the market.
What is secondary market?
Secondary market is also known as the âafter marketâ where second-hand securities are traded. Basically, those securities that have been issued in the primary market are traded in this market. In this market, there is no intervention of the issuing company. Share valuation is based on the performance of the share in the market. Income is generated via sale of shares from one investor to another in this market.
Most of the capital market transactions take place on secondary market. There is no limit on the frequency of trading in a security and the process is quick as well. Through the secondary market, companies can raise finance on primary market since investors are assured that they will be able to resell these securities to quickly recover their money.
How does secondary market work?
Usually smaller investors trade in the secondary market. Traders start investing in stocks that have potential of earning them profits. Based on their risk tolerance, future plans and expected ROI, they can choose for either short term or long term trading. Once the bought security starts going into profit or it touches the stop loss, the trader can sell the security. Investors earn profit after the deduction of brokerage. These days, investors can also use apps to avoid brokerage charges as there is no broker involved for trading through these apps.
Types of Instruments in Secondary Market
Following are the different types of financial instruments that are traded in the secondary market:
- Fixed income instruments: These include primary debt instruments including bonds, debentures and preference shares. They ensure regular payments in the form of interest and repayment of principal on maturity.
- Variable income instruments: These instruments have almost equal risk and gain opportunities. They have a higher rate of returns as compared to fixed income instruments. Equity and derivatives are the two types of variable income instruments.
- Hybrid instruments: These instruments have the characteristics of both equity and debt instruments. They have medium returns since they earn more rate of returns than fixed-income securities but lesser than pure variable income securities. Convertible debentures are one of the types of hybrid instruments.
Why Do People Trade in Secondary Market?
Here are the reasons why people trade in the secondary market:
- Liquidity: The secondary market provides an avenue for investors to easily buy and sell securities, offering liquidity to their investments.
- Price Discovery: It helps in determining the market price of a security based on its demand and supply, ensuring transparent and fair pricing.
- Diversification: Investors can diversify their portfolio by trading various securities in the secondary market, reducing the risk associated with holding a single type of asset.
- Accessibility: The secondary market is accessible to a wide range of investors, from institutional to individual, allowing them to participate in the trading of securities.
- Economic Indicators: The performance of the secondary market often reflects the overall health of an economy, making it a vital indicator for policymakers and analysts.
- Capital Gains: Investors seek to profit from the appreciation in the value of securities over time, aiming for capital gains.
- Dividend Income: By trading in the secondary market, investors can acquire shares of companies that offer dividends, providing them with a source of regular income.
- Flexibility: The secondary market offers flexibility as investors can easily adjust their portfolios in response to changing financial circumstances or market conditions.
- Safety: Regulated secondary markets have stringent rules and oversight, ensuring that trading is conducted in a fair and transparent manner, providing a level of safety to investors.
- Information Dissemination: The secondary market plays a crucial role in disseminating information about companies and their performance, ensuring that investors make informed decisions.
Conclusion
Hope this article has helped understand the difference between the primary market and the secondary market. Investors can keep on investing in both these financial markets are available to investors. However, the category of investors differs for both. Based on your risk tolerance, capacity, and future investment plans, you should choose the instruments suitable for your needs.
FAQs
Which are the types of secondary markets in India?
Stock exchange and Over the Counter markets are two types of secondary markets in India.
List some features of a secondary market.
Secondary market is a market to trade existing securities. The prices of securities in secondary market are predetermined by demand and supply of securities.
Which are some of the advantages of primary market?
Companies can issue IPOs which help in raising capital at lower cost. These securities have higher liquidity since these can be sold immediately in the secondary market. Primary market helps in saving economy.
Which securities are issued in a primary market?
Rights issues, public issues, private placements and preferential issues are issued in a primary market.
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