Primary and secondary markets · RiskAtoms Academy

By the end you will be able to

1Tell raising new capital in the primary market apart from trading existing securities in the secondary market.
2Follow where the money goes in each market.
3Explain why a working secondary market matters to issuers.
4Name the main ways new securities are sold: IPO, follow-on offering, bond auction and private placement.

Why it matters

When a famous company's share price jumps 10% in a day, the company itself does not get a cent richer. So why do its managers watch the price so closely?

Core explanation

New money, or old securities changing hands?

Every security has two lives. First it is created and sold by its issuer to raise money. Then it is traded, perhaps for decades, between investors. These two lives happen in two different markets.

Primary market

New securities are sold for the first time.

The money goes to the issuer: a company, government or bank raising funds.

Secondary market

Existing securities are traded between investors.

The money goes from buyer to seller. The issuer receives nothing.

A handy test: follow the cash. If it ends up with the issuer, you are in the primary market. If it ends up with another investor, you are in the secondary market. Step through the life of an imaginary robotics company and watch the counter.

Step throughKestrel Robotics goes public

1 / 5

Plan

The company needs money

Kestrel Robotics wants $200m to build a factory. It decides to sell new shares to the public in an initial public offering (IPO).

Cash to the company so far$0nothing raised yet

How new securities are sold

IPO and follow-on offerings for shares, usually run by underwriters using bookbuilding.
Syndicated bond issues for companies and banks: a group of banks sells new bonds to investors in much the same way.
Auctions for most government bonds. The US Treasury, Germany's Finance Agency and the UK Debt Management Office all sell new bonds this way: investors bid, and the best bids win.
Private placements, where securities are sold to a few large investors without a full public offer.

The secondary market then takes over, on exchanges or between dealers. Lesson L1.1.04 looks at those venues.

Sort itPrimary or secondary?

0 of 6 right

A tech company lists on the Nasdaq and sells 20 million new shares.
A pension fund sells 10-year UK government bonds to a bank.
The US Treasury auctions new 2-year notes.
You buy shares in an Australian bank through a trading app.
A utility sells new bonds privately to three insurers.
A fund sells all its shares in a retailer after a bad profit warning.

Why issuers care about the secondary market. The issuer gets nothing from secondary trading, yet it matters a great deal to them. Think about why before you reveal each card.

Why the secondary market matters to the issuer

Worked example

A government bond, from auction to resale

The German government sells new 10-year bonds at auction. Amounts are illustrative, in euros, and bond prices are quoted per 100 of face value. Try each step before revealing it.

Following the money

Step 1 of 5

1
The auction (primary market)
The government offers €4bn of face value. Banks bid, and the bonds are sold at an average price of 99.20.

The bond's price fell from 99.20 to 98.70, perhaps because interest rates rose. That loss falls on whoever holds the bond, not on the government. L1.4.03 shows why bond prices move with rates.

Regulatory lens

Selling securities to the public is regulated. Before a public offer, the issuer must normally publish a prospectus approved by the regulator: under the Securities Act of 1933 in the US, the Prospectus Regulation in the EU, and the UK's own prospectus rules. Secondary trading falls under market abuse rules, which ban insider dealing and market manipulation.

Looking ahead: investment banks' underwriting role is covered in L1.2.02, and the risk a bank takes when it promises to buy unsold securities returns when we study market risk.

Sparks

SparkThe record IPO

Saudi Aramco's IPO in December 2019 raised about $25.6 billion, the largest on record at the time, and about $29.4 billion once the underwriters used their option to sell extra shares. Only around 1.5% of the company was sold.

SparkWhy it is called a greenshoe

In many IPOs the underwriters may sell up to 15% more shares than planned, to steady the price in the first weeks. This is the “greenshoe” option, named after the Green Shoe Manufacturing Company, whose 1960s offering was among the first to use it.

Key takeaways

In the primary market, new securities are sold and the issuer receives the money.
In the secondary market, existing securities change hands and the issuer receives nothing.
Follow the cash: if it reaches the issuer, the trade is primary.
New securities are sold by IPOs and follow-on offerings, syndicated bond issues, government auctions and private placements.
Issuers depend on the secondary market: it makes investors willing to buy, sets the cost of new money and signals what investors think.

Reaction

Check what stuck

Glossary

Issuer: The company, government or other body that creates a security and sells it to raise money.
Primary market: The market where securities are sold for the first time, so the issuer receives the money.
Secondary market: The market where investors trade securities that already exist; the issuer receives nothing.
IPO: Initial public offering: a company's first sale of shares to the public, usually followed by a listing on an exchange.
Follow-on offering: A later sale of new shares by a company whose shares already trade.
Underwriter: A bank that organises a new issue, finds buyers and often promises to buy any shares left unsold.
Bookbuilding: Collecting orders from investors before an issue to set the price and decide who gets what.
Auction: A sale in which investors bid and the issuer accepts the best bids; how most governments sell their bonds.
Private placement: A sale of new securities to a small group of chosen investors rather than to the public.
Prospectus: The legal document describing a security, its issuer and its risks, published before a public offer.

Deep Dives & Origins

Deep Dives

Brealey, Myers and Allen, Principles of Corporate Finance, McGraw-Hill, the chapter on how corporations issue securities. Intermediate.
Mishkin, The Economics of Money, Banking and Financial Markets, Pearson, “An Overview of the Financial System”. Beginner.

Origins

Brealey, R. A., Myers, S. C. and Allen, F., Principles of Corporate Finance, McGraw-Hill.
Mishkin, F. S., The Economics of Money, Banking and Financial Markets, Pearson.
Saudi Aramco, IPO prospectus and stabilisation announcements, 2019 and 2020.
Regulation (EU) 2017/1129 (the Prospectus Regulation); US Securities Act of 1933.

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