Primary Market
What is Primary Market?
The primary market is where new securities are sold for the first time by the issuer, so the money raised goes directly to the company or government.
In the primary market a company or government creates new securities and sells them to investors, and the cash paid moves straight to the issuer. An initial public offering is the best known case, but every new bond issue and every batch of extra shares sold by an already public company is also a primary market transaction. Investment banks usually underwrite the sale, meaning they help set the price and often buy the whole issue in order to resell it. This is the market that finances real investment, because it converts saving into funds a firm can spend on factories, research or hiring. The contrast is the secondary market, where those same securities later change hands between investors and the issuer receives nothing.
Primary Market: a worked example
A company sells 10 million new shares at $18 each in its public offering, raising $180 million in gross proceeds. The underwriting banks charge a 6 percent fee, which is $10.8 million, so the company keeps $169.2 million to spend on its business. The next morning an investor who bought at the offering sells one of those shares to somebody else for $22. That $22 goes to the selling investor. The company receives none of it, because the trade happened in the secondary market and created no new share.
The mistake students make with primary market
Students assume a company collects cash whenever its shares are bought and sold, so a rising stock price must be filling the firm's bank account. The issuer is paid once, at issuance in the primary market. Every later trade moves money between investors. A higher share price does help the firm indirectly, since it can issue new shares on better terms next time, but it is not revenue.
Primary Market questions
Is an IPO a primary market transaction?
Yes, an initial public offering is a primary market transaction, because the shares are newly created and the proceeds go to the issuing company. Once those shares begin trading on an exchange, every purchase of them after that is a secondary market transaction. A company can return to the primary market later with a follow-on offering of additional new shares.
What is the difference between the primary market and the secondary market?
The primary market is where securities are issued and the issuer receives the money, while the secondary market is where investors trade those existing securities among themselves and the issuer receives nothing. A security passes through the primary market once and can trade in the secondary market indefinitely.
Who buys securities in the primary market?
Most primary market buyers are institutions such as pension funds, insurers and mutual funds, which take large blocks through the underwriting banks. Retail investors can sometimes take part in a share offering through a broker. Government bond auctions sell mainly to a set of approved dealers, who then resell the bonds to everyone else.
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