 Personal Finance Powerpoint Presentation. Primary and secondary markets. Prepare to get financially fit by practicing personal finance. Most of this information can be found at Investopedia, a look at primary and secondary markets, which you can find online. Take a look at the references, resources, continue your research from there. This by Brian Beers, updated August 29th, 2021. In prior presentations, we've been looking at investment goals, investment tools, investment strategies, keeping that in mind. We're now looking at and considering what is primary and secondary markets. The word market can have many different medians, but it is used most often as a catch-all term to denote both the primary market and the secondary market. So when we hear the term market, just in a generic form, we're usually having catch-all term for both the primary and secondary market. In fact, primary market and secondary market are both distinct terms. The primary market refers to the market where securities are created, while the secondary market is one in which they are traded among investors. So when we think about the primary market, one of the parties involved are usually gonna be the company involved that's looking for financing or funding, possibly issuing stocks, possibly issuing bonds. When we're looking at the secondary market, we're typically thinking of traders trading these securities, not having the primary issuer being the one issuing the stocks or bonds, for example, but rather trading trader to trader on the secondary market, generally speaking. Knowing how the primary and secondary markets works is key to understanding how stocks, bonds, and other securities trade. Without them, the capital markets would be much harder to navigate and much less profitable. So clearly these markets are gonna be a tool for it's just like basically a trail connecting two people together so that they can trade, right? The silk road or so on and so forth. So we need these kind of things to get the people that want to have interactions together in such a way that they can have trust in what is happening so that we could facilitate trade, which will typically increase the economy, increase growth, increase GDP. So we'll help you understand how these market work and how they relate to individual investors. The primary market. The primary market is where securities are created. It's this market that firms self float new stocks and bonds to the public for the first time. So we're gonna be issuing, for example, the stocks for the first time coming from the company itself, not buying the stocks from a secondary investor. The primary company is coming from them. That is gonna be the primary market for the case of stocks. An initial public offering or IPO is an example of a primary market. So when you get that initial stocks, remember that corporations may not be publicly traded, may not be on an exchange. If they decide to then go on the exchange, then they're generally gonna be trying to raise capital through, for example, issuance of stocks. And the first time they do that, they've got that initial public offering known as the IPO. So these trades provide an opportunity for investors to buy securities from the bank that did the initial underwriting for a particular stock. An IPO initial public offering occurs when a private company issues stock to the public for the first time. For example, company ABCWXYZ Incorporate hires five underwriting firms to determine the financial details of its IPO initial public offering. The underwriters detail that the issue price of the stock will be $15. Investors can then buy the IPO at this price directly from the issuing company. So now the stock is issuing the stocks, which represent kind of a portion of ownership in the equity interest and the corporation in exchange for funds, which of course then are gonna go to the company itself, hopefully to finance the company, hopefully to help the company grow so that it can generate more revenue in the future and create value for now some of the new owners that are now purchasing the stocks in the form of the initial public offering stocks. So this is the first opportunity that investors have to contribute capital to a company through the purchase of its stock. A company's equity capital is comprised of the funds generated by the sale of stock on the primary market. So when you're gonna record this basically from an accounting standpoint, they're gonna be increasing their cash and they're gonna get the equity side increasing equity assets minus liabilities equal in the equity equity representing in essence the owners, stockholders share of what the company has in essence, as opposed to third party liabilities. So types of primary offering, a rights offering issue permits companies to raise additional equity through the primary market after already having securities enter the secondary market. Current investors are offered pro-rated rates based on the shares they currently own and others can invest a new and newly minted shares. So after the initial public offering, the company can still issue more shares if they so choose which are still coming from the company in that case therefore primary market but are not the initial or first time public offering. Other types of primary market offerings for stocks include private placement and preferential allotment. Private placement allows companies to sell directly to more significant investors such as hedge funds and banks without making shares publicly available. While preferential allotment offers shares to select investors, usually hedge funds, banks and mutual funds at a special price not available to the general public. Similarly, businesses and governments that want to generate debt capital can choose to issue new short and long-term bonds on the primary market. New bonds are issued with coupon rates that correspond to the current interest rates at the time of issuance which may be higher or lower than pre-existing bonds. So when on the bonds side of the thing that's the other typical way that a company might try to generate capital, generate money that they can then invest, of course they can generate revenue but when they're trying to basically get money in some other way through investments they can issue the stock which means they're giving an equity interest in the company or they can issue the bonds which is kind of like a debt situation except that instead of going to the bank they're issuing the bonds to the public and the public then are buying the bonds. If you buy the bonds directly from the company then they might be issuing those bonds at the current market price so you might buy them at the par value or the value of the face amount of the bond and then as time passes as we know then that price will change as market conditions change and you could then sell the bonds possibly on a secondary market at a premium or discount perhaps. So the important thing to understand about the primary market is that securities are purchased directly from an issuer so when you hear primary market you're dealing directly from the issuer that typically being the corporation either stocks or the bonds. Most transactions however happen on the secondary market because the whole goal of these kind of instruments, stocks, bonds is that we're trying to make them somewhat uniform in nature so that they can be easily compared and traded on the secondary market which increases the flow in people's capacity to value these kinds of things and it allows money to flow in a little bit more easily allows trust to happen. So the secondary market for buying equities the secondary market is commonly referred to as the stock market. So this includes the New York Stock Exchange the NYSE NASDAQ and all major exchanges around the world that define characteristic of the secondary market is that investors trade amongst themselves so now they're just trading like baseball cards they're just, I already bought them from the shop now we're just trading them up but we know what the value of a like card is or like stock is because they're all basically the same if they're from the same card or something like that. So that is the secondary market investors trade previously issued securities without the issuing companies involvement for example, if you go to buy Amazon stock you are dealing only with another investor who owns shares in Amazon, Amazon is not directly involved with the transaction. So if you buy Amazon stock and you're not buying from the primary market then you're paying somebody else Amazon's not getting your money they're getting your money in a bunch of other ways possibly but they're not getting your money from that stock sale because they already issued the stock some other investor is getting the money that you're paying for it. So in the debt markets while a bond is guaranteed to pay its owner the full par value at maturity this date is often many years down the road. So if you have a bond that's kind of a debt instrument that means that you're gonna get paid typically that means that the company owes you money if you have stock the company might still be paying you like dividends for example, if you have a bond they're gonna pay you in the future but you might be able to trade the bond early. So instead bond holders can sell bonds on the secondary market for a tidy profit if interest rates have decreased since the issuance of the bond. So you gotta understand the relationship of the interest rates and the price of the bond so you can think about selling the bond at a premium and a discount and so on we'll dive into that in example problems making it more valuable to other investors due to its relatively higher coupon rate. So the secondary market can be further broken down into two specialized categories. We've got the auction markets and the auction markets all investors and institutions that want to trade securities congregate in one area and announce the prices at which they are willing to buy and sell. These are referred to as bid and ask prices. The idea is that an efficient market should prevail by bringing together all parties and having them publicly declare their prices because then you have a market condition and people have disinterested interests and therefore you would have them bid and hopefully you're gonna have a market condition happening thusly which would hopefully be an optimal price. Thus theoretically the best price of a good need not be sought out because the convergence of buyers and sellers will call cause mutual agreeable prices to emerge. So this is what we kind of want to happen in a market generally because that's what economists generally think leads to efficiency when you have two people that are markets that are self interested that have competing interests compete for prices. So the best example of an auction market is the New York Stock Exchange, the NYSE dealer markets. In contrast a dealer market does not require parties to converge in a central location. So notice that this requirement to converge in a central location you can imagine being more important before time you might imagine now you got well now we've got ways to converge other ways than physically in a particular location. So maybe we can have different structures for example and still have kind of like a market bidding situation. So rather participants in the market are joined through electronic networks. The dealers hold an inventory of security then stand ready to buy or sell with market participants. These dealers earn profits through the spread between the prices at which they buy and sell securities. An example of a dealer market is the NASDAQ in which dealers who are known as market makers provide firm bid and ask prices at which they are willing to buy and sell securities. The theory is that competition between dealers will provide the best possible price for investors. The OTC market. Sometimes you'll hear a dealer market referred to as an over the counter OTC market. The term originally meant to relatively unorganized system where trading did not occur at a physical place as was described above but rather through dealer networks. The term was most likely derived from the off Wall Street trading that boomed during the great bull market of the 1920s in which shares were sold over the counter in stock shops. In other words, the stocks were not listed on a stock exchange, they were unlisted. So if you think about it in that sense, they're not on the stock exchange. And you can think one of the things that the stock exchange did and we're looking at the 1920s now, right? So one of the things that the stock exchange kind of does is it requires some standardizations of the financial statements and so on and so forth, which hopefully will reduce fraudulent kind of transactions for people misrepresenting. Because remember that the whole trust thing is an important thing. And of course in the 1930s and so we had the great depression which included downturns in the stock market. Of course, there were a whole lot of stuff going on at that point in time. But in any case, over time, however, the meaning of OTC began to change. The NASDAQ was created in 1971 by the National Association of Securities Dealers, the NASD, to bring liquidity to the companies that were trading through the dealer network. At the time, few regulations were placed on shares trading over the counter, something the NASD sought to improve. So now remember, we always have this delicate balance between regulations that are necessary and then getting too heavy on the regulations, which could be costly and not allowing for flexibility for improvements in technology and so on and so forth. A certain set of regulations, at least self-regulations within a market can be good just like in a profession, trying to self-regulate to some degree so that you can keep up the ethics so you can keep up the trust involved because again, no transactions can happen. If there's no trust, people just will stop trading. So you wanna be able to not stop this kind of scamming misrepresentation. So as the NASDAQ has evolved over time to become a major exchange, the meaning of over the counter has become fuzzier. So nowadays the term over the counter generally refers to stocks that are not trading on a stock exchange such as the NASDAQ NYSE or American Stock Exchange, the AMEX, AMEX. This means that the stock trades either on the over the counter bulletin board, the OTCBB or the peak sheets. Neither of these networks is an exchange. In fact, they describe themselves as providers of pricing information for securities. The OTCBB and peak sheet companies have far fewer regulations to comply with than those that trade shares on the stock exchange. So again, one of the costs of trading on the exchange is the regulations you've gotta jump through. And again, we're balancing those regulations with the absorbent and the big costs with regulations. So most securities that trade this way are penny stocks or are from very small companies. For these reasons, while the NASDAQ is still considered a dealer market and technically an OTC, today's NASDAQ is also a stock exchange. And therefore it is inaccurate to say that it trades in unlisted securities. Third and fourth markets. You might also hear the term third and fourth markets. These don't concern individual investors because they involve significant volumes of shares to be transacted per trade. So you're talking high volume trades here, which again, for the individual investor, possibly not the case. Typically individual investors might be trading smaller shares of stock or possibly dealing with other tools and instruments like ETFs and mutual funds. So these markets deal with transactions between broker dealers and large institutions through over-the-counter electronic networks. The third market companies, OTC transactions between broker dealers and large institutions. The fourth market is made up of transactions that take place between large institutions. The main reason these third and fourth market transactions occur is to avoid placing these orders through the main exchange, which could greatly affect the price of the security. Because access to the third and fourth markets is limited, their activities have little effect on the average investor. What's the bottom line then? Although not all of the activities that take place in the markets, we have discussed affect individual investors. It's good to have a general understanding of the market's structure. So the way in which securities are brought to the market and traded on various exchanges is central to the market's function. We wanna have an idea of course, what stocks are, what bonds are and how they are actually physically trading on the market. Because again, that'll give us some idea of course on how best to make our decisions related to them. So just imagine if organized secondary markets did not exist. You'd have to personally track down other investors just to buy or sell a stock, which would not be an easy task. So again, these systems that we have that we kind of take for granted these days that actually connect the buyer and the seller kind of like the silk road, you know, that can put the two people together that want the goods is a value. That's a valuable thing. So in fact, many investors' scams revolve around securities that have no secondary market because unsuspecting investors can be swindled into buying them. So if you're buying something that's not on the market then you're typically, you may have less trust in it because the markets are designed to increase the level of trust within it. And that could be a good thing. So the importance of markets and the ability to sell a security liquidity is often taken for granted, but without a market investors have a few options and can get stuck with big losses. When it comes to the markets, therefore what you don't know can hurt you. And in the long run, a little education might just save you some money.