Meaning of Primary and Secondary Market
The primary market is where companies sell new shares to the public to collect funds for business expansion or acquiring another company. This market helps attract savings and contributes to economic growth. Some common types of issues in the primary market include Offer for Sale, Public Issue, Bonus Issue, and Right Issue.
The secondary market is where investors trade existing securities such as shares, bonds, and other financial instruments. In the secondary market, these trades happen either on stock exchanges or directly between buyers and sellers, like over-the-counter (OTC) markets.
In conclusion, both the primary market and the secondary market serve important purposes. The primary market is where new shares are first issued, while the secondary market is where these shares are bought and sold after their initial issuance.
Difference Between Primary Market and Secondary Market
Primary Market and Secondary Market Examples
Primary Market Examples:
Initial Public Offering (IPO): A company like Zomato or Paytm issues new shares to the public for the first time to raise capital for growth. This is a typical example of a primary market transaction.
Right Issue: A company provides extra shares to its existing shareholders at a reduced price. For instance, Reliance Industries could issue additional shares to current investors to secure funding for a new project.
Bonus Issue: A company distributes free shares to its current shareholders based on the number of shares they already own. For example, Tata Motors may offer bonus shares as a way to reward its investors.
Secondary Market Examples:
Stock Exchanges: The Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) are examples of secondary markets where investors buy and sell shares of companies like Infosys, Tata Motors, or HDFC Bank.
Bond Markets: Investors buying and selling government or corporate bonds in markets like the NSE Bond Market or OTC (over-the-counter) bond market are examples of secondary market activities.
ETFs (Exchange-Traded Funds): Investors trade ETFs on the secondary market, like the Nifty 50 ETF, where they buy and sell based on the price determined by supply and demand.
Functions of Primary Market and Secondary Market
Primary Market Functions:
Raising Money: Helps companies get funds by selling new shares or bonds.
Setting Prices: Decides the price of shares and bonds.
Helping Growth: Supports business expansion and economic growth.
Investment Opportunities: Allows people to buy new shares directly from companies.
Providing Funds: Makes it easier for businesses to raise money.
Secondary Market Functions:
Easy Buying and Selling: This lets investors buy and sell shares and bonds.
Setting Prices: Prices are based on supply and demand.
Helping Investment: Provides a place for trading investments.
Spreading Risk: Offers different investment options to reduce risk.
Market Efficiency: Keeps the financial system running smoothly.
Conclusion
Both the primary and secondary markets play crucial roles in the financial system. The primary market helps companies raise funds by issuing new shares or bonds, while the secondary market allows investors to buy and sell those securities. The primary market focuses on raising money for business growth, while the secondary market provides liquidity and opportunities for trading investments. Understanding these markets is essential for investors and businesses alike to navigate the world of finance effectively.
FAQs on Primary Market and Secondary Market
1. What is the fundamental difference between the primary market and the secondary market as per the CBSE syllabus?
The fundamental difference lies in the type of securities traded. The primary market, also known as the new issue market, deals exclusively with the issuance of new securities (like shares and debentures) directly from a company to investors. The capital raised here goes to the company. In contrast, the secondary market, or stock market, involves the trading of existing, previously-issued securities between investors. Here, the company is not directly involved, and the money is exchanged between the buyer and seller of the security.
2. What are the main methods a company can use to issue securities in the primary market?
A company can raise capital in the primary market through several methods, including:
- Initial Public Offering (IPO): When an unlisted company issues new securities to the public for the first time.
- Follow-on Public Offer (FPO): When an already listed company issues additional shares to the public.
- Rights Issue: An offer to existing shareholders to buy additional shares, typically at a discounted price.
- Private Placement: Selling securities to a select group of institutional investors rather than to the public at large.
- Offer for Sale (OFS): Promoters of a company sell their shares directly to the public.
3. How is the price of a security determined differently in the primary and secondary markets?
In the primary market, the price of securities is determined and set by the company's management, often in consultation with merchant bankers. This can be a fixed price or determined through a book-building process. In the secondary market, the price is not fixed by the company. Instead, it fluctuates based on the independent market forces of demand and supply for that specific security among investors on a stock exchange.
4. What role do stock exchanges like the NSE and BSE play in the financial markets?
Stock exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are the physical and institutional form of the secondary market. Their primary role is to provide a structured, regulated, and transparent platform for investors to buy and sell existing securities. They facilitate liquidity (easy conversion of shares to cash) and continuous price discovery for financial assets.
5. Why is a healthy secondary market considered essential for the growth of the primary market?
A healthy secondary market is crucial for the primary market because it provides liquidity and an exit route for investments. Investors are more willing to subscribe to new issues (IPOs, FPOs) in the primary market if they are confident that they can sell those securities later in a robust secondary market. Without this assurance of liquidity, the process of capital formation in the primary market would be severely hampered.
6. If a company doesn't receive money from secondary market trades, why is the share price in this market important to the company?
Even though the company does not receive funds from secondary market transactions, the share price is vital for several reasons:
- It acts as a public barometer of the company's performance and investor confidence.
- A strong and stable share price enhances the company's reputation and goodwill.
- It determines the company's market capitalization and is a key factor in its valuation for potential mergers or acquisitions.
- A higher share price makes it easier and more favourable for the company to raise new capital in the future through a Follow-on Public Offer (FPO).
7. What is the key distinction between an 'Initial Public Offering' (IPO) and a 'Rights Issue'?
The key distinction lies in who the securities are offered to. An Initial Public Offering (IPO) is the process where a privately held company offers its shares to the general public for the first time to become a publicly listed entity. A Rights Issue, on the other hand, is an invitation by an already listed company to its existing shareholders to purchase additional shares, giving them a 'right' to maintain their proportional ownership.
8. What is the core function of the primary market in an economy like India's?
The core function of the primary market is capital formation. It acts as a direct channel to transfer savings from households and investors to corporations that need funds for productive purposes. This process facilitates investment in new projects, expansion of existing businesses, and modernization, thereby contributing directly to economic growth and development.
