In this article, I will show you how a stock traded on the primary market and a stock traded on the secondary market work. I will also highlight the difference between the two, and discuss the trading mechanics involved in both.
Equity markets are an important part of the financial system. It is a powerful instrument that functions as an auction for the exchange of capital and credit and has two independent and indivisible segments: Primary and secondary markets.
Primary Market: Any company that issues securities is required by the SEBI to give you a chance to buy their stock. This is called the “primary market”, and it is usually found online at major stock exchanges. The primary market is the first place you will discover a company’s stock, but it can also happen in the secondary market.
Secondary Market: If you want to buy shares of stock in a particular company that isn’t yet publicly traded, you can do so through the secondary market. This is typically done by brokers, who buy and sell the stock, or dealers, who buy and sell shares of stock on behalf of their clients. There are three primary variations of secondary market transactions.
In financial terms, the stock market can be defined as a process that enables and facilitates the exchange of stocks and bonds, commodities, etc:
- Issuance of new shares (IPO)
- Raising capital (IPO, bonds)
- Risk transfer (forward market)
- Transfer of liquidities (money markets)
- International trade (currency markets)
In this article, we will discuss the primary and secondary markets to understand exactly how the stock market works. Let’s get started.
1. Primary market
The primary market is the market for new issues, i.e. the market for fresh capital. It provides for the sale of new securities. The primary market offers issuers of securities, such as. B. Governments and businesses, the ability to borrow money to meet investment needs or fulfil an obligation.
Companies mainly issue debt and equity instruments (stocks, bonds), while governments issue debt instruments (treasury bills). Issues may be made at par or at a discount or premium and subsequently converted into various forms such as shares, debt securities, etc. However, these issues can be issued both domestically and internationally.
Emissions on the primary market take place through public or private placements. When securities are secured so that new investors can become part of the shareholder family, this is called a public offering. Social problems can be divided into several categories:
Initial public offering (IPO):
An IPO takes place when an unlisted company undertakes a new issue of securities. This opens the possibility of listing and trading the issued securities on the securities markets.
Follow-on public offering (FPO):
An FPO occurs when an existing publicly-traded company makes a new public offering of securities or a public offering through an offering document.
Also read: What are the Nifty and the Sensex? Fundamentals of the stock market (for beginners).
When an issuer issues securities to a specific group of persons not exceeding 49 members, it is a private placement. However, this is not a rights issue or a social issue. Private placement of shares by a listed issuer can be done in two ways:
If a listed issuer issues shares or convertible securities to a group of persons selected in accordance with the requirements of the supervisory authority, this is called a preferential offer. The issuer must comply with various regulations including disclosure, pricing, blockchain, etc.
Qualified institutional placement (QIP)
If a listed issuer issues shares or securities convertible into shares only to purchasers from qualified institutions in accordance with the requirements of the supervisory authority, this is known as placement with qualified institutions.
2. Secondary market
The secondary market allows participants who own securities to adjust their holdings in response to changes in their risk and return assessments. After being issued on the primary market, the new securities are traded on the stock exchange (secondary market) until the day they are listed. A stock exchange listing provides liquidity and creates a reputation.
The secondary market operates through two channels, the over-the-counter market and the exchange market.
OTC markets are informal markets where the execution of transactions is negotiable. Most government securities are held in the over-the-counter market. In addition, all spot transactions involving the trading of securities for immediate delivery and payment take place in the OTC market.
Another possibility is trading through the infrastructure of exchanges where financial instruments are traded in cash. The four main players in the securities market are investors, issuers, intermediaries and regulators.
- Investors can be divided into retail investors (HNI, retail investors) and institutional investors (banks, insurance companies, mutual funds, FIIs, etc.).
- Issuers include governments, corporations, financial institutions, etc.
- Intermediaries include stock exchanges, stockbrokers, custodian banks, investment bankers, FIIs, investment funds, debt managers, etc.
- Regulators include central banks.
The two main stock exchanges in India are the Bombay Stock Exchange and the National Stock Exchange.
Secondary market components:
The securities market is divided into different markets and in these markets, different types of instruments are traded.
1. Cash contracts/brokers:
In the equity segment, you can trade stocks, bonds, warrants, mutual funds and ETFs.
2. Equity derivatives market:
The derivatives segment allows for trading in derivative instruments. It is a product whose value is derived from the value of one or more underlying variables and is called the basis (underlying, index). The underlying asset can be a stock, currency, commodity or other assets. There are two types of derivatives (futures and options).
3. Debt market:
The debt market includes the bond markets that provide financing through the issuance of bonds.
4. Corporate bond market:
Bonds issued by companies are corporate bonds and are issued to meet the needs of expansion, modernization, restructuring of operations, mergers and acquisitions.
5. Foreign Exchange market:
The foreign exchange market (FX) is the place where foreign exchange transactions are carried out. The Forex market is currently one of the largest and most liquid financial markets in the world. It involves trade between major banks, central banks, traders, speculators, corporations, governments and other financial institutions.
6. Forward commodity market:
Commodity markets enable the exchange of raw materials or semi-finished products. Commodities are traded on standardized commodity exchanges, where they are bought and sold on the basis of clearly defined contracts. Gold, silver and agricultural products are also traded in this market.
Final Thoughts – Primary market and Secondary market
You should now have some understanding of primary and secondary markets. Let’s recap what we talked about in this article.
The primary market, also known as the new issue market (NIM), is a market where new shares are issued and the public buys shares of the company directly, usually through an IPO or FPO.
On the other hand, the secondary market is where previously issued securities are traded. The second market concerns the indirect buying and selling of shares between investors. The brokers are intermediaries and the investors/traders receive the amount when the shares are sold.
So much for this post. I hope this was helpful. Good investment.
Frequently Asked Questions
What are the differences between primary and secondary market?
How do primary markets work?