What is the primary market and why is it important?

By Indeed Editorial Team

Published 20 September 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

The primary market is an important term a company may encounter when investing in stocks. It's a crucial element of securities investment that allows businesses and other entities to raise capital in a cost-effective way. Learning about this helps to develop your understanding of trading and investment in the financial market. In this article, we discuss what the primary market is and how it works, why it's important and the different types, list the benefits and outline how it differs from the secondary market.

What is the primary market?

Otherwise known as the new issue market (NIM), the primary market is a segment of the capital market where new securities are issued and become available for companies, governments and other groups to obtain. Securities are certificates or other financial instruments that hold monetary value. This market is only exclusive to new securities that companies haven't previously traded on any exchange.

Companies issue securities directly onto the market for investors to purchase or trade. Businesses do this to obtain financing through equity-based or debt-based securities. The former is where investors hold ownership in an entity while debt-based securities are investments that require investors to repay them over a set period, allowing the company to receive new income. This allows investors to purchase securities directly from the issuing company due to no prior trades having taken place.

Related: What is market size? (Plus a guide to calculating it)

How does NIM work?

The NIM process involves new stocks and bonds becoming available to the public for the first time. A company usually raises an initial public offering (IPO) to make these securities public. During an IPO, a company sells its shares directly to investors in this market. This process, which involves selling new stock to investors to raise investment capital, is underwriting. Once this initial sale is complete, investors conduct further trading on the secondary market.

The secondary market is where the bulk of exchange trading occurs each day as investors buy and sell from one another. Banking institutions act as middlemen between issuing companies and investors in this market. Underwriters purchase unsold shares, earning a commission in the process. They then sell the securities to investors. Investors may also depend on underwriters to determine whether the returns on securities outweigh the risks.

Related: What is market failure? (Definition, types and solutions)

Why is NIM important?

NIM is important because it marks the launch of a new security in the financial marketplace. It's a way for governments and companies to pay debts or capitalise on new opportunities by attracting investors and raising money. Securities investments also enable investors to generate new forms of income and to back promising ventures. NIM is also essential for identifying, assessing and processing newly issued securities. IPOs provide a detailed assessment of the viability of a project and outline the issuing company's liquidity ratio, debt-equity ratio and equity ratio for investors to consider.

Related: The primary sector (with examples of primary sector jobs)

Ways of issuing securities

There are several ways to share securities, including:

Initial public offering

This is the most common method for issuing securities to the public at large. IPO occurs when a company issues shares for the first time. By offering equity to investors, companies transform from private limited companies to publicly-trading entities, labelling the process as going public. IPOs allow companies to raise funds while investors can invest in the company for the first time. The company hires designated investment banks to determine the original price of the new shares and perform other underwriting responsibilities for a particular stock.

These securities then become listed on a stock exchange for trading purposes once the company raises the necessary capital. Newly public-trading companies may use capital to repay debts, increase liquidity or improve existing infrastructure amongst other things.

Rights issue

A rights issue occurs when a company wants to raise more capital from its existing shareholders. NIM involves offering existing shareholders more shares at a discounted price compared to the price offered to the rest of the marketplace. The company offers a number of shares on a pro-rata basis, meaning each person receives a share amount based on their share of the whole.

Private placement

Private placement is when a company issues securities to a corporate entity, individual person or small group of investors rather than to the public marketplace. These entities or individuals are usually accredited or institutional. These primary securities may include stocks, bonds or other types of securities, such as mutual funds or options. Issuing private placement is easier when compared to an IPO. This is because the regulatory standards are less rigorous and incur less cost and time. Private placement is a suitable option for newly-established companies that have just commenced operations but are still in their primary years.

Preferential allotment

This is the quickest method through which companies are able to raise capital for business operations or needs. Preferential allotment occurs when a company offers shares to a particular group of investors at a special or discounted price. This price is different from the publicly traded share price offered to the public at large. This option is available to both listed and unlisted companies that have their sights set on a select group of investors.

NIM involves paying preference shareholders dividends before other shareholders. Dividends are rewards paid to shareholders for their investment in a company's equity. Preferential allotment allows the issuing company to determine the basis of the allotment as it remains independent from any mechanisms such as pro-rata.

Related: Debt market vs. equity market: what is the difference?

Advantages of NIM

There are several benefits, including:

Helps raise capital economically

It allows companies to raise capital more cost-effectively. Companies are able to raise capital at relatively lower costs and the securities issued have high liquidity since investors are able to sell them in the secondary market almost instantly. High liquidity, therefore, makes the selling process more seamless. Existing companies are able to use this capital upon rendering their products obsolete to venture into new areas of production and expand their operations.

Mobilises savings

They're essential for mobilising savings in the economy. Investors use their communal savings to invest in other channels and financial investment options. Mobilising savings allows investors to capitalise on new opportunities and bring in more revenue.

Reduces chances of price manipulation

There are fewer chances of price manipulation when compared to the secondary market. Inflated or deflated security prices affect the free and fair operation of the market. Reduced price manipulation encourages better transparency and cooperativeness.

Offers diversification

The marketplace is an avenue for diversification for investors. This helps reduce the quantum of risk and opens them up to various ventures. Diversification allows investors to allocate their investments across asset classes in several financial instruments.

Related: 5 types of market differentiation strategies (Plus benefits)

Primary vs secondary market

The secondary market is where investors trade existing bonds, shares, debentures and other securities with other investors as part of a stock exchange. Securities enter the secondary market after the initial trade on the primary. Secondary market trades involve a buyer and seller, with the stock exchange facilitating the transaction. The issuing company isn't involved in the sale of its securities on the secondary market. Some key differences to consider between the primary and secondary markets include:

Naming

The primary is sometimes referred to as the new issue market because it involves the selling of securities for the first time to the general public via an established IPO. Conversely, the secondary market is often referred to as the after market. Remembering these names can help you to easily remember what each market does.

Nature of transaction

The primary involves investors buying securities directly from the issuing company at the IPO. Yet the secondary market involves investors trading shares with each other on the day's most prominent indices. Investors determine prices according to basic supply and demand forces.

Payment party

Companies profit from the amount raised through the sale of shares in the primary market. Profits come from investors who provide capital according to IPO stipulations. The secondary market is where investors benefit from selling securities to other investors.

Security of sale

Securities may fail to sell once on the primary. This prompts underwriters to step in and purchase them. Since investors are able to sell securities on the secondary market an infinite number of times, it has a better security sale rate.

Price fluctuation

IPO underwriters, otherwise known as banking institutions, serve as intermediaries in the primary. This helps prevent severe price fluctuations that affect the transparency of the market. Brokers serve as intermediaries on the secondary market, leaving it more subject to price increases and decreases to broker a good deal for investors.

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