Types of capital market: Primary market and secondary market

Types of Capital Market:

Recall that the capital market is a financial market that utilizes equity and debt securities as its form of investment.

You can think of equity securities as shares. These shares are sold by a corporation or company, and are purchased by individuals or organizations, both of whom are referred to as investors. By buying a corporation's equity (shares), the investors automatically become shareholders of the corporation. This implies that the investors own a portion of the corporation in accordance to their shares. For this reason, they will get an appropriate dividend if the corporation makes profit.

Debt securities are traded in the bond market. They are utilized by corporations and government agencies to raise capital through the sale of bonds.

Please read the introduction of capital market alongside its functions here.

The capital market consist of two types of markets. These are the primary and secondary market. They are explained below:

• Primary Market 

The primary market, sometimes called a new issue market, is considered a first-tier security market. In this market, corporations sell new securities which include bonds, stocks, and shares to institutions (acting as investors), in return for their capital investment. Therefore, the securities in the primary market are traded for the very first time.

The corporations that operate the primary market include issuing houses like central banks, commercial banks, mortgage banks, merchant banks, insurance companies, and so on.

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The fundraising process of a corporation (or company) in the primary market may occur in four ways. These are:

1. Initial Public Offering: This is the first public offering a corporation issues concerning the availability of its securities. The price of securities, e.g, stock, is set by the corporation involved; but must be highly regulated. In Nigeria, the Securities and Exchange Commission (SEC) regulates this process.

2. Follow-on Public Offer: After the issuance of an initial public offering, the corporation can still offer their current investors the opportunity to purchase more shares. Therefore, those who had initially bought shares through the initial public offering can buy additional shares in view of potentially earning more dividend. However, it is worthy of note to state that follow-on public offer can be dilutive or non-dilutive.

3. Private Placement: The sale of equities and bonds are not made public. Rather, only a few chosen investors are made aware of this opportunity.

4. Preferential Allotment: Preference is given to the sale of securities. In this regard, the corporation will often sell its securities to a few privileged persons (or organizations) at a discounted rate.

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The sale of securities in the primary market may occur through a process termed underwriting. When this is accomplished, investment banks are hired to match the corporations and investors with regards to their investment and risk profile.

When all is set, a public accounting firm may be hired to aid the corporation in preparing, auditing, reviewing, and taxation processing of their financial statement in order to ensure transparency of their financial outlook.

Please read on bookkeeping and accounting explained with their differences here.

With respect to the above paragraph, the important components of a primary market are explained below:

• Corporations: They are the businesses that require capital to grow and run their operations. To achieve this, they sell their bonds and stocks (securities) online through various trading applications. Examples of corporations include amazon, apple, meta, toyota, Dangote group, alphabet inc, and so on.

• Please read on the advantages and disadvantages of corporations here.

• Institutions (Investors): The institutions consist of the investors and fund managers who buy debts and equities (bonds and shares). They therefore provide capital to the corporations, with a goal of making profits. As a result, these institutions can become a part owner of the corporation. The investors can be both institutional and retail investors.

• Investment Banks: These are intermediaries that connect corporations to the institutions, while also calculating the risk of investment alongside their profit ratio. Through their actions, they facilitate deals between the corporations and institutions. Examples of institutional banks include JP Morgan, Goldman Sachs, Bank of America, Barclays, Morgan Stanley, Wells Fargo, HSBC, UBS, Citigroup, Credit Suisse and so on.

• Public Accounting Firms: The corporations will typically hire a public accounting firm to ensure the financial transparency of their business. Public accounting firms are involved in financial reporting, making financial statements, financial auditing, alongside tax calculations.

In Nigeria, the primary market is regulated by the Securities and Exchange Commission (SEC). They are the apex regulator of the Nigerian capital market.

Corporations (or companies) utilize the primary market to attract investments through the selling of ownership shares (with regard to equities), or taking on debts (with regards to bonds). This is done in order to raise more funds, with a probable promise of offering consistent profit to the shareholders and bondholders respectively.

You can read on the advantages of inflation in economics here.

• Secondary Market

In the secondary market, bonds and shares which had already been issued can again be traded by buyers and sellers through investment banks, or via the buyers locating the sellers, perhaps through a central market place, or an exchange over the counter. The stockbrokers and issuing houses are examples of the secondary market.

In simple terms, the secondary market deals with the buying and selling of old or existing securities that had already been issued.

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In comparison to a primary market, the operations of a secondary market is less restricted. In fact, they are considered as a second-tier securities market since existing securities are traded. Hence, they exist as an appendage (or attachment) to the primary market (stock exchanges and central banks).

The secondary market can be viewed to provide a continuous trading platform where investors can buy and sell securities at anytime during open market hours. This is quite different from the primary market where securities are open for subscription only for a limited period.

For the secondary market to function properly, the stock exchange must provide a platform for trading securities. Here, the sellers who own securities can interface directly with buyers. This will enable the sellers to easily sell their securities at a time that best suit them.

Please read key points for students in economics here.

Characteristics of Secondary Market

Below are some characteristics of the secondary market:

• Buying and selling of securities take place continuously in the secondary market. This is quite different from the primary market where the purchase of securities are opened for a limited time.

• There is no impact on the finances of corporations that issues securities. This is so since the trading actions (buying and selling) are carried out between the investors.

• The price of securities in the secondary market are determined by the forces of demand and supply.

• The secondary market provides more liquidity than the primary market. In this regard, high volume of securities are traded during the market's opening hours.

• Existing investors can easily monetize their investments (in a corporation or company) through the secondary market.

You can read on commodity market here.

Types of Secondary Market

Generally, there are two types of secondary market. These are the auction market and dealer market respectively.

• In the auction market, investors announce the price they are willing to buy and sell securities. Therefore, the initial investors will typically set profitable prices for their securities in this market.

• The dealer market requires that dealers who had initially bought securities will eventually set the buy and sell prices of their securities. Having multiple dealers in this market may lead to a healthy competition.

Please read the concept of marketing and its branches here.

In essence, the primary and secondary market work quite differently towards achieving a similar goal. This goal is to serve as platforms that facilitate the trading of financial securities between buyers and sellers.

You can read on the concept and law of demand here.