The financial market is based on the activity of two compartments whose functions are different and complementary: the primary market and the secondary market.
- The primary market is the “ new ” market, that of securities issues. Savers can acquire, at the time of their creation, securities through banks or brokerage firms.
- The secondary market is the ” second-hand market,” where transactions take place between those who wish to sell securities already issued and those who wish to acquire them. It is on this market that old securities are listed. It is organized in the form of Stock Exchanges. The exchanges that take place there do not concern the issuers of securities and do not contribute directly to their financing.
What is the role of the primary financial market?
The primary market performs two essential functions in an economy: the financing of economic agents and the allocation of resources:
The primary market fulfills the function of financing the economy. It makes it possible to reconcile the needs of lenders and borrowers. Three categories of issuers of securities (borrowers) operate on the primary market: companies, the State and local authorities as well as financial institutions.
Companies
Also, a primary market allows companies to obtain the capital they need to finance an investment. In return for the capital raised, companies issue securities using three methods: IPO, capital increase, and bond issue.
- Initial public offering: the operation consists of a company wishing to access the stock market to sell investors part of the shares making up the share capital. The introduction takes place through a public sale offer and is therefore accompanied by an opening of the company’s capital to the public.
- A capital increase is an operation that consists of a company increasing the amount of its share capital through new contributions. For this, the company issues new shares and sells them to investors.
- Issuance of bonds: only large companies can issue bonds on the stock exchange. They must offer higher rates than the states. The rates are all the higher as the “rating” given by the rating agencies is lower.
State and local authorities
States issue long-term bonds (over five years) to cover their budget deficits. These are treasury bonds. In addition, States issue short bonds and treasury bills to finance their cash needs due to the gap between their income and their expenditure. Government bonds are considered the safest securities on the market.
Financial intermediaries
To obtain resources, financial intermediaries use the capital markets. They can issue bonds, shares, or hybrid securities (a mixture of shares and bonds) on the financial market. For this, they use the same methods as companies.
Read also: The importance of economic policies for the development of Brazil
What is the role of the secondary financial market?
The secondary market performs three essential functions: fixing the price of securities, the liquidity of securities, and restructuring the capital of listed companies:
The fixing of the price of securities
On the secondary market, transactions are carried out after the confrontation of a large number of offers and requests to establish the course (the price) of the securities, which is fixed according to the law of supply and demand. If the security is more demanded than offered, its price rises; if it is more offered than asked, its price declines. By fixing the price, the financial market helps to determine the value of companies, i.e., their market capitalization (market capitalization = share price x number of shares).
The price reflects investors’ expectations about the future and the results of listed companies. If investors anticipate an increase in a company’s earnings, they buy its shares, which increases demand and drives up the price. Conversely, if investors anticipate a decline in a company’s results, they sell its shares, which increases the supply and lowers the price. However, investors’ expectations are sometimes irrational, which generates speculative bubbles and a disconnect between prices and company results.
Liquidity of securities
Liquidity is the characteristic of a Security that can be bought and sold quickly, without high costs and without a discount on the capital. The possibility for investors to easily sell their securities is a determining factor in encouraging them to subscribe when new securities are issued. It is the secondary market that ensures the liquidity of securities, shares, and bonds. A market is deemed to be all the more liquid when it hosts a large number of transactions and operators.
Restructuring of the capital of listed companies
The secondary market allows the external growth of companies through the acquisition of packages of shares to take stakes in other firms or merge with them.
- The stock market pick-up: transactions on the stock market being free, it suffices to take control of a listed company, to buy half of the shares plus one. This method is long and expensive. It is visible, which gives the managers of the target company time to get organized.
- A public takeover bid is a financial transaction allowing one company to take control of another, with or without the agreement of its managers, by offering the shareholders of the target company to buy back their shares at a price higher than the price observed on the market. This procedure is strictly regulated by the Feds.
- Public exchange offer is similar to the takeover bid, but shareholders are offered payment in the form of securities, generally those of the company carrying out the operation.
In addition to these three economic functions, the secondary market provides operators with transaction transparency and security.
Leave a Reply