Primary Capital Markets vs. Secondary Capital Markets: What’s the Difference?
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Primary Capital Markets vs. Secondary Capital Markets: An Overview
A capital market is a part of the financial market that connects investors with capital-seeking entities. Suppliers in the market offer bonds, shares, and other investments in exchange for capital from investors. The primary capital market is the venue where corporations issue new investment vehicles to sell to investors while the secondary capital market is where buyers and sellers trade securities that have already been sold.
Key Takeaways
- Capital markets are divided into primary capital markets and secondary capital markets.
- Primary capital markets are where new securities are sold to investors.
- Secondary capital markets refer to exchanges where financial securities are sold after going through primary markets.
- Individual investors are excluded from primary markets, which is why they participate in secondary markets.
- Prices are set during IPOs on the primary market but tend to more volatile on secondary markets because of supply and demand.
Primary Capital Markets
The primary capital market is where new securities are sold to investors for the first time. As such, this market, which is simply referred to as the primary market, is responsible for creating new issues. In many cases, the new issue takes the form of an initial public offering (IPO). These aren’t physical locations, but a concept that represents the place where securities are initially sold.
To register new securities on the primary capital market, the issuing company must hire an underwriting firm to review the offering. This firm then creates a prospectus outlining the price and other details of the securities to be issued. The issues are marketed through a roadshow or dog and pony show, and an exchange is selected.
The securities must be sold in a short period to meet the required volume. Issuing companies may hire investment bankers to obtain commitments from institutional investors to purchase large volumes of the offering through the primary capital market, which is why small retail investors can’t and don’t participate in this market.
All issues on the primary market are subject to strict regulation. Companies must file statements with the Securities and Exchange Commission (SEC) and other securities agencies and must wait until their filings are approved before they can go public. Prices are often volatile in the primary market because demand is often hard to predict when a financial security is first issued. That’s why a lot of IPOs are set at low prices.
The primary capital market is also called the new issues market while the secondary capital market is commonly referred to as the aftermarket.
Secondary Capital Markets
The secondary capital market is where securities are traded after the company sells its offerings on the primary market. It is also referred to as the stock market. The New York Stock Exchange (NYSE), London Stock Exchange (LSE), and Nasdaq are secondary markets.
The secondary market has two different categories:
- The auction market is home to the open outcry system where buyers and sellers congregate in one location and announce the prices at which they are willing to buy and sell their securities. The NYSE is one such example.
- The dealer markets allow people to trade financial securities through electronic networks. Most small investors trade through dealer markets.
Participants in the secondary capital market, which is simply referred to as the secondary market, include
Exchanges, issuers, market makers, clearinghouses, traders, broker-dealers, and investors participate in the secondary capital market or the secondary market. Small investors can trade financial securities in this venue because they can buy smaller volumes than what is required through IPOs. Anyone can trade securities here as long as they pay the asking price per share. The volume of securities traded varies daily as supply and demand fluctuate. This also has a big effect on the price.
A broker typically purchases the securities on behalf of an investor in the secondary market. Unlike the primary market, where prices are set before an IPO takes place, prices on the secondary market fluctuate with demand. Investors also have to pay a commission to the broker for carrying out the trade. Sales take place between independent buyers and sellers since the initial offering is complete. The exception, though, is a stock buyback when a company wants to repurchase its shares.
A company can raise more equity in the primary market after entering the secondary market through a rights offering. The company will offer prorated rights based on shares investors already own. Another option is a private placement, where a company may sell directly to a large investor, such as a hedge fund or a bank. In this case, the shares are not made public.
Examples of Primary Capital Markets and Secondary Capital Markets
Let’s take a look at some common examples of both primary capital markets and secondary capital markets.
Primary Capital Markets
As noted above, investors can purchase newly issued financial securities through the primary capital markets. New securities are purchased directly from the issuer. Some of the most common examples of this market include:
- IPOs
- Currencies, which may be offered by governments so investors can take advantage of exchange rates
- Treasury auctions, which allow investors to purchase Treasury securities, including T-bills, directly from the government
Secondary Capital Markets
Stock exchanges are the most well-known examples of the secondary capital market. The NYSE, LSE, Nasdaq, and other international exchanges allow investors and other entities to trade securities that went through the primary market.
Other common examples of the secondary market include loan exchanges and over-the-counter (OTC) markets, which allow smaller companies that don’t meet the listing requirements of exchanges to sell their shares.
Key Differences
| Primary Capital Markets | Secondary Capital Markets | |
|---|---|---|
| Also Known As | Primary markets or new issues market | Secondary market or aftermarket |
| Securities Sold | Newly issued | Previously issued |
| Participants | Issuing companies, banks, underwriters, marketing companies, institutional investors | Investors, broker-dealers, market makers, clearinghouses, traders, issuing companies, exchanges |
| Price of Securities | IPOs are set low to curb volatility | Volatile, depend on supply and demand |
What Is a Special Purpose Acquisition Company?
A special purpose acquisition company (SPAC) is a shell company formed to raise capital through an initial public offering. The company has no other purpose but to sell shares and use the capital to merge with or acquire a private company through a reverse merger.
SPACs came with fewer regulatory requirements, allowing companies to go public in a matter of months. They became a popular way for companies that wanted to go public to raise money without having to go through the traditional IPO process and paperwork. Financial regulators in the U.S. took notice when SPACs became more commonplace, and increased the financial disclosure requirements for these transactions.
What Are Capital Markets?
Capital markets are venues where buyers and sellers come together to exchange capital. Primary capital markets are where issuers sell newly issued financial securities and investment products to certain investors while secondary markets are open to all investors, broker-dealers, and others for securities after they’ve gone through the primary market. Initial public offerings are issued on the primary market. Stock and bond markets are considered secondary markets.
What’s the Difference Between a Capital Market and a Financial Market?
Capital markets are venues where capital seekers go to raise money. This capital can be used to fuel growth, fund investments, or pay debts. Financial markets, on the other hand, is a broader term used to describe the arena where individuals and companies buy and sell different financial products like stocks, bonds, financial contracts, and banking products.
The Bottom Line
Capital markets play a very important role in the financial industry because they give buyers and sellers a venue to exchange capital. Corporations, governments, institutional investors, and retail investors all participate in these markets. These markets are divided into two different categories: primary capital markets, where new issues are sold, and secondary markets, which allow individual investors to buy and sell financial securities.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Investors should consider engaging a qualified financial professional to determine a suitable investment strategy.
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