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Companies and financial accounting
Companies and financial accounting

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2.4 Primary and secondary markets

A financial market is a place where those who wish to borrow or raise capital can meet those who are willing to provide it. There are two main types of financial market.

  1. Primary markets deal in new issues of finance, such as issues of new shares or debentures. When a public limited company issues shares for the first time to be sold on the stock exchange, it is called Initial Public Offering (IPO). When the company later seeks to increase its share capital it can do so through a secondary public offering.
  2. Secondary markets deal in trading of what might be termed ‘second-hand’ or ‘pre-owned’ financial assets of various kinds: for example, securities, bonds, debentures/loan stock. They do not provide new funds, but allow holders of existing assets to sell them on to other investors. It is thought that a well-developed secondary market should reduce price volatility of traded assets through regular trading activities. Well-developed secondary markets are essential for diversification, risk shifting, hedging and arbitrage.

The UK has a capital market in the form of the London Stock Exchange (LSE), which deals in two major types of security – company securities (shares and long-term loan stock/debentures) and public sector stocks. The advantage of the LSE is that it provides liquidity, is transparent and it is regulated. AIM is the London Stock Exchange’s international market for smaller companies.

Furthermore, unlisted public limited companies can offer their shares and debentures on the over the counter (OTC) market. That is, on a market that is not a stock exchange.

Activity 7 Primary and secondary markets

Timing: Allow about 10 minutes

The purpose of this activity is to learn to distinguish between primary and secondary markets.

Public limited companies raise capital in primary markets. They do not raise capital in secondary markets. Why then are secondary markets very important for their ability to raise capital?

Feedback

One answer is liquidity. Investors value liquidity because they are more willing to buy shares and other securities if they know that they can easily sell them, when they have to or want to sell them.

Secondly, share prices give an indication of the market’s opinion on how well the company is doing. Listed companies will want to make sure that their share price is slowly but gradually going up, because that is what makes investors want to invest in their shares.