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What Is Primary Market?
A primary market is a platform where securities are created for sale to investors for the first time. Here, the investors are the direct buyers of the assets and securities, which means the stocks or equities are sold to them as soon as they are introduced in the market.
The government, corporations, and other entities launch their securities in the primary market to raise funds and finance their projects and businesses. Investors, as a result, get an opportunity to have these stocks and equity at a comparatively lesser price to trade further in the secondary market.
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- The primary market is a capital market where new debt-based, equity-based, or other asset-based securities are created and directly purchased by the investors from the issuer.
- Once the securities are sold for the first time, they are ready to enter the secondary market for further sale and purchase.
- Public issues, rights issues, preferential issues, and private placement are issues that classify a primary market.
- New issue offering, underwriting, and distribution are the three primary functions of these markets.
How Does A Primary Market Works?
A primary market is a capital market that puts securities for sale initially. These assets enter the next market when the primary buyers trade them further. This next marketplace becomes their secondary market. In short, the primary market is the platform wherefrom investing begins.
Firms introduce new shares, bonds, bills, and notes in the market and sell them to investors for the first time to raise capital. The investment banks set the initial price, which receives a fee in return for undertaking sales. However, the remaining proportion of the earnings goes to the issuers.
Companies file statements with the Securities and Exchange Commission (SEC) and other agencies as required to start with the primary market transaction. As soon as the stocks, bonds, and other securities are traded for the first time in the primary market, they enter the secondary market for further sale to other investors.
Video on Primary Market
Types
Primary markets are classified into four categories based on the issues they come up with.
The first type is the public issue, whereby the assets and securities are put for sale to the public as soon as they are created. It is this feature of this market that makes the offering be called an Initial Public Offering (IPO).
The next is the rights issue. This is where companies that have already issued securities earlier on the platform invite their existing shareholders to buy the new shares they launch. As the process involves the retention of rights of the existing shareholders with the same company, it is referred to as a rights issue.
The private placement market is where firms introduce securities for sale to a small group of investors. Here, the companies can maintain private status. Usually, start-up ecosystem participants opt for such issuance to approach ultra-high-net-worth individuals (UHNWIs) to raise capital. Moreover, issuing these securities is easier than IPOs as the regulations are lenient for the former.
As the name implies, the preferential issue deals with issuing stocks, bonds, notes, bills, and other assets to a selected group of investors. Both listed and unlisted firms can issue securities in this market, which are neither public issues nor rights issues.
Functions
The functions, which help understand the primary market definition more clearly, are classified into – offering, underwriting, and distribution.
The primary market is also known as a New Issue Market (NIM) as it offers brand new issues to investors to invest in. It means this is the platform where the securities have been introduced before being available for sale on any other platform, not even the stock exchange. The issuance involves an assessment of how viable a project is. The market considers the debt-equity ratio and other factors before accepting a firm’s security.
Underwriting, the buying of unsold assets or securities, is yet another essential function of this market. Primarily, the financial institutions act as underwriters on whom the investors depend for gauging the risk associated with the investment and assessing the expected returns. The underwriters, whether financial institutions or individuals, receive a commission for facilitating the trade on this platform.
Last but not least is the distribution of the issues that these markets involve. Here, the new issues are distributed to investors and introduced for further trade. In short, this market is the center where individual and institutional investors know about the new securities in the market and start investing. This is how the distribution starts and further trading occurs as soon as the securities leave the primary market and enter the secondary markets.
Examples
Let us consider the following primary market examples to understand the concept even better:
Example #1
Start-up A bids for a major project and manages to crack it. However, completing the project requires significant funds. Thus, it introduces security in the primary market to raise funds for the first time. Considering the business plan that the company has, an investment bank agrees to invest in the security for a charge. This helps the firm to raise capital to start working on the project put on hold.
Example #2
Recently, technology ace Liquidnet announced the progress of electronification in the new bond issuance process of primary markets. The firm has been working on the same for years. The technology would ensure convenient transmission and execution of the buy side orders in the live market.
Advantages & Disadvantages
Primary markets introduce new shares for further distribution, which makes it the starting point of investing. However, there are specific cons that one should know of before considering these marketplaces as flawless. Here is a list of the pros and cons of these markets:
| Pros | Cons |
|---|---|
| Lower cost of raising capital | Investors might not get all details related to investment until they invest in the IPOs. |
| Securities are highly liquid. | The degree of risks differs from one security to another |
| There is least or no chance of price manipulation | It might not be a good alternative for small investors |
| Saves amount, which could be used to finance further investment options | |
| Not subject to market fluctuations |
Frequently Asked Questions (FAQs)
The type of investment that investors can expect to make in these markets could be an Initial Public Offering (IPO) to first-time buyers. It is opted for when the firms issuing securities go public. In addition, they can invest in rights issues, which imply the availability of securities for sale to the firm's existing shareholders first. Further, the investment could be for only a small group of investors to make the process quick or for preferred investors, especially ultra-high-net-worth individuals (HNWIs), for capital raising purposes only.
The major market participants are the government, corporations, institutions, investment banks, and public accounting firms.
Primary and secondary markets are interdependent. While the former creates and introduces the securities in the market and distributes them for further sale, letting them enter the latter, the secondary market is the platform that ensures these assets and securities are saleable.
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This article has been a guide to what is Primary Market & its definition. Here, we explain how it works, its types, functions, examples, advantages, and disadvantages. You may have a look at other Investment Banking articles for more information.
