Wednesday, August 26, 2009

Primary versus secondary markets

The financial markets may also be dividend into primary markets and secondary markets. The primary market is for the trading of new securities never before issued. Its principal function is the raising of financial capital to support new investment in buildings, equipment, and inventories. You engage in a primary-market transaction when you purchase shares of stock just issued by a company, borrow money through a new mortgage to purchase a home, negotiate a loan at the bank to restock the shelves of your business, or purchase bonds just issued by the local school district to construct new classrooms.
In contrast, the secondary market deals in securities previously issued. Its chief function is to provide liquidity to security investors-an avenue for converting stocks, bonds, and other securities into ready cash. If you sell shares of stock or bonds you have been holding for some time to a relative or friend or call a broker and place an order for shares currently being traded on the American stock exchange, you are participating in a secondary-market transaction.
The volume of trading in the secondary market is far larger than trading in primary market. However the secondary market does not support new investment. Nevertheless, the primary and secondary markets are closely intertwined. For example, a rise in interest rates or security prices in the secondary market usually leads to a similar rise in the prices or rates on primary-market securities and vice verse. This happens because investors frequently switch from one market to another in response to differences in price and yields. Many financial institutions are active in both markets.

No comments: