Buying stock: Primary and Secondary market?

 

Buying Stock: Primary and Secondary Markets

If you buy shares in a company, it doesn't necessarily mean you're buying it from another shareholder who wants to sell their stock. There are two main markets where securities are transacted: the primary market and the secondary market.

When stocks are first issued and sold by companies to the public, this is called an initial public offering, or IPO. This initial or primary offering is usually underwritten by an investment bank that will take possession of the securities and distribute them to various investors. This is the primary market. Investors participating in the primary market are thus buying stock directly from the issuing company.

Prices on the primary market tend to be set prior to the IPO, so the investor knows how much they will pay in order to invest in shares of that company's stock. However, this market is usually dominated by sophisticated and experienced investors, such as banks, pension funds, institutional investors or hedge funds.

Primary Market

 What Is a Primary Market?

A primary market is a source of new securities. Often on an exchange, it's where companies, governments, and other groups go to obtain financing through debt-based or equity-based securities. Primary markets are facilitated by underwriting groups consisting of investment banks that set a beginning price range for a given security and oversee its sale to investors.

Once the initial sale is complete, further trading is conducted on the secondary market, where the bulk of exchange trading occurs each day.

KEY TAKEAWAYS

• In the primary market, new stocks and bonds are sold to the public for the first time.
• In a primary market, investors are able to purchase securities directly from the issuer.
• Types of primary market issues include an initial public offering (IPO), a private placement, a rights issue, and a preferred allotment.
• Stock exchanges instead represent secondary markets, where investors buy and sell from one another.
• After they’ve been issued on the primary market, securities are traded between investors on what is called the secondary market—essentially, the familiar stock exchanges.

Understanding Primary Markets

The primary market is where securities are created. It's in this market that firms sell or float (in finance lingo) new stocks and bonds to the public for the first time. 

Companies and government entities sell new issues of common and preferred stock, corporate bonds and government bonds, notes, and bills on the primary market to fund business improvements or expand operations. Although an investment bank may set the securities' initial price and receive a fee for facilitating sales, most of the money raised from the sales goes to the issuer.

The primary market isn't a physical place; it reflects more the nature of the goods. The key defining characteristic of a primary market is that securities on it are purchased directly from an issuer—as opposed to being bought from a previous purchaser or investor, "second-hand" so to speak.

Secondary Market

What Is a Secondary Market?

The secondary market is where investors buy and sell securities they already own. It is what most people typically think of as the "stock market," though stocks are also sold on the primary market when they are first issued. The national exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ, are secondary markets.

Understanding Secondary Market

Though stocks are one of the most commonly traded securities, there are also other types of secondary markets. For example, investment banks and corporate and individual investors buy and sell mutual funds and bonds on secondary markets. Entities such as Fannie Mae and Freddie Mac also purchase mortgages on a secondary market.

Transactions that occur on the secondary market are termed secondary simply because they are one step removed from the transaction that originally created the securities in question. For example, a financial institution writes a mortgage for a consumer, creating the mortgage security. The bank can then sell it to Fannie Mae on the secondary market in a secondary transaction.

KEY TAKEAWAYS

• In secondary markets, investors exchange with each other rather than with the issuing entity.
• Through massive series of independent yet interconnected trades, the secondary market drives the price of securities toward their actual value.