Companies can raise external funds through borrowing or issue of shares. If securities are issued they are sold in the Primary Market. The Primary Market is purposely for trading of new securities (IPOs) never before issued. That is to say, securities available for the first time are offered through the Primary Market. The principal function of the Primary market is to raise financial capital to support new investments in building, equipment and
Though companies can sell directly to the general public, they usually use underwriters (investment bankers) who handle the details of the new issue and sale to the investor. Underwriters normally buy the new issue at an agreed price from the issuer and sell it at a higher price to the public. Sale through the investment bankers (underwriters) can take the form of “best efforts” or agency agreement. Under such agreement, the investment banker does not buy the new issue but uses his best effort to sell it. Any unsold securities are returned to the issuer.
Once an investor purchases new issues, they change hands in the Secondary Market. Secondary markets are for existing securities that are currently traded between investors. These markets create price and allow for liquidity. If secondary markets did not exist, investors will have no place to sell their investment. Without liquidity many investors will not invest all. Thus, the chief function of the secondary markets is to provide an avenue for converting financial instruments into ready cash (liquid asset). Volumes of trading in securities take place in the secondary market than the primary market. However, the secondary market does not support new investment. Broadly, there are two types of secondary markets namely organized exchanges (stock exchange) and over the counter (OTC) markets.