The stock market refers to the buying and selling stocks, which are shares of equity ownership in companies. Stocks can be purchased from a company at an initial public offering or on the secondary market through exchanges.
A stock market combines primary, secondary, and OTC markets. Each market plays an essential role in the overall functioning of a stock market. For example, NSE, BSE, and NYSE are stock exchanges, whereas NASDAQ is an OCT market.
When people refer to the stock market going up or down, they generally refer to whether an index has gone up or down. This is because the index tracks a particular portfolio of stocks. The most commonly used indices are the NSE 50, Bank Nifty, and BSE SENSEX in India. In addition, some major global indices are S&P 500, NASDAQ, and the Dow Jones Industrial Average. Investors use these indices to compare an investment’s expected success or failure.
What is a Primary Market?
A Primary Market is the market that provides a channel for the issuance of new securities by issuers; for example, government companies or corporates may raise capital through the primary market. Securities, also known as financial instruments, might be issued at face value or a discount or premium to face value in various forms such as equity, debt, etc.
Features of Primary Market
- Securities are issued by a company directly to investors.
- A company receives the money and issues new securities to investors.
- Companies use primary markets to set up new ventures or businesses and modernize existing businesses.
- The primary market performs the crucial function of facilitating capital transfer from savers to users in an economy.
The companies that issue their shares are called issuers, and the process of issuing shares to the public is known as a public issue. This process involves various intermediaries like Merchant bankers, Bankers to the Issue, Underwriters, Registrars, etc. These intermediaries must register with the market regulator, for example, SEBI in India. In addition, they must abide by the prescribed norms to protect the interest of investors.
Public Issue of Shares
When a company raises funds by issuing its shares, debentures, or bonds to the public through an issue of an offer document (also known as a prospectus), it is called a public issue.
Initial Public Offer
When an unlisted company makes a public issue for the first time and gets its shares listed on a stock exchange, the public issue is called an Initial Public Offer (IPO).
Further Public Offer
When a listed company makes another public issue to raise capital, it is called Follow on Public Offer (FPO).
Offer for Sale
Institutional investors, like venture funds, private equity funds, etc., invest in an unlisted company when it is small or initially. Subsequently, when the company becomes large, these investors sell their shares to the public through the issue of an offer document, and the company’s shares get listed on a stock exchange. This is called an Offer for Sale. The proceeds of this issue go to existing investors and not the company.
Indian Depository Receipts (IDR)
A foreign company on a stock exchange abroad can raise money from Indian investors by issuing shares. These shares are held in trust by a foreign custodian bank against which a domestic custodian bank gives an instrument called Indian depository receipts (IDR). An IDR could be traded at a stock exchange like any other share, and the holder is entitled to rights of ownership, including receiving a dividend.
Other Types of Shares Issue
When a company raises funds from its existing shareholders by issuing them new shares or debentures, it is called a rights issue. The offer document for a rights issue is called the Letter of Offer, and the issue is kept open for 30-60 days. Existing shareholders are entitled to apply for new shares in proportion to the number of shares already held. For example, in a rights issue of a 1:5 ratio, investors have the right to subscribe to one new share of the company for every five shares already held by the investors.
The company issues new shares to its existing shareholders in a bonus issue. In a bonus issue, new shares are issued out of the company’s reserves (accumulated profits), and shareholders need not pay any money to the company to receive new shares.
What is a Secondary Market?
A secondary market is where securities are traded after being offered to the public in the primary market and listed on the Stock Exchange. The majority of the trading is done in the secondary market.
The secondary market comprises the equity market and the debt market.
For a general investor, the secondary market provides an efficient platform for securities trading. In a secondary market, transactions are done among the investors. The issuing company does not participate in such transactions, and the valuation of a share is based on its performance in the market. In a secondary market, income is generated by the sale of a claim by one investor to another.
Functions of a Secondary Market
- It provides liquidity to investors for their assets.
- In addition, it allows investors to check the price of various financial instruments like shares and bonds.
- The secondary market provides a platform where investors can trade on different securities like bonds, shares, debenture, and other financial instruments.
- An efficient secondary market keeps the transaction cost low.
Types of Secondary Market
There are two types of secondary markets:
- The Counter Market, and
- Stock Exchange
Over-the-Counter Market (OTC)
It is a market in which buyers and sellers engage in the trading of securities amongst themselves. An OTC market is precarious as the parties deal directly with each other. In an OTC market, stocks of smaller companies are traded as they find it difficult to meet an exchange requirement for listing.
A stock exchange provides a centralized platform where securities trading can occur without contacting buyers and sellers. A stock exchange acts as an intermediary between buyers and sellers. An essential aspect of the stock exchange is that it also works as a counterparty for each trade, i.e., it guarantees the execution of trade and its settlement.
Conclusion: Essential Points for Investors
- A primary market is where new shares are sold for the first time, whereas the secondary market allows investors to trade previously issued securities.
- Investors buy securities directly from issuers through an IPO or FPO in a primary market. On the other hand, a secondary market is where investors trade shares.
- A primary market is referred to as the New Issue Market (NIM), and the secondary market is known as; The After Market.
- In a primary market, shares could be sold only once, but issued shares could be traded an infinite number of times in a secondary market.
- Shares couldn’t be traded in a secondary market until they had been issued in the primary market.
- Companies that issue shares through public issues take the premium or profit in a primary market. In a secondary market, those who trade shares at an exchange make a profit, not the company that issues shares.
- Underwriters serve as intermediaries in a primary market during an Initial Public Offering, whereas brokers act as the intermediaries in a secondary market.
- In a primary market, the price at which shares are issued is usually in a predefined range or fixed. Still, in the secondary market, the price fluctuates based on several factors, like demand and supply of shares, the company’s performance, corporate actions, etc.