Primary and Secondary Markets

Financial Markets

• Financial markets are organizations that facilitate the trade in financial products, such as stock exchanges, which facilitate the trade in stocks and bonds.

Types of Financial Markets

• Capital Market: provides financing through the issuance of shares and enables subsequent trading; includes stock markets, bond markets, money markets, derivatives markets, foreign exchange markets, and commodity markets.

Capital Market

• A market for securities where companies and governments can raise long-term funds.
• Includes the stock market and bond market.
• Financial regulators oversee the capital markets to ensure investor protection against fraud.
• Consists of primary markets and secondary markets.

Primary Market

• Deals with the issuance of new securities.
• Companies, governments, or public sector institutions can obtain funding through the sale of new stock or bond issues.
• Features:
  • Market for new long-term capital.
  • Securities are sold for the first time.
  • Issued by the company directly to investors.

Secondary Market

• The market for trading securities that have already been issued in an initial offering.
• Once a newly issued stock is listed on a stock exchange, investors and speculators can easily trade on the exchange.

Primary Market vs. Secondary Market

• Primary market: market for new securities issued by the company to the public for the first time.
• Secondary market: market where new securities already issued are traded.
• Primary market involves direct company involvement, while the secondary market does not.
• Primary market deals with new securities, while the secondary market deals with already issued securities.

Participants in the Capital Market

• Investors: lifeline of any capital market; attract savings of investors, including retail investors, institutional investors, and foreign portfolio investors.
• Stock Exchange: a place where securities issued by issuer companies are listed and traded.
• Depository: holds securities of investors in electronic form and provides other services like pledge, safekeeping, and stock lending and borrowing.

Capital Market Instruments

• Financial instruments with maturity over one year, such as bonds and stocks.
• Available instruments include:
  • Shares (equity and preference)
  • Debentures/Bonds
  • Depository Receipts
  • Derivatives

Shares

• Type of security signifying ownership in a corporation and giving:
  • Voting rights
  • Dividend entitlement
• Two main types of shares:
  • Equity shares
  • Preference shares

Preference Shares

• Carry a preferential right to be paid in case of company bankruptcy or liquidation.
• Preference shareholders have negligible voting rights but higher claim on assets and earnings.

Debentures/Bonds

• Long-term debt securities among corporates.
• Certificate evidence of a lender-creditor relationship.
• Bonds with maturities less than one year are called money market instruments.

Depository Receipts (GDR)

• Provide international investors with local settlement.
• Issuer pays dividends to the depository in the domestic currency, which is then converted to dollars for onward payment to receipt holders.
• GDRs bear no risk of capital repayment and may be issued with warrants attached.

Derivatives

• Financial instruments deriving value from another financial price (underlying).
• Most important derivatives include futures and options.

Futures

• Agreements to buy or sell the underlying security at a future date and specified price.

Options

• Give the buyer the right to buy/sell the underlying asset at a predetermined price within or at the end of a specified period.
• There are two types of options: call and put.