PRIMARY VERSUS SECONDARY MARKETS
Financial markets function as both primary and secondary markets for debt and
equity securities. The term primary market refers to the original sale of securities by
governments and corporations. The secondary markets are those in which these
securities are bought and sold after the original sale. Equities are, of course, issued solely
by corporations. Debt securities are issued by both governments and corporations. In the
discussion that follows, we focus on corporate securities only.
Primary markets
In a primary market transaction, the corporation is the seller, and the transaction
raises money for the corporation. Corporations engage in two types of primary market
transactions: public offerings and private placements. A public offering, as the name
suggests, involves selling securities to the general public, whereas a private placement
is a negotiated sale involving a specific buyer.
By law, public offerings of debt and equity must be registered with the Securities
and Exchange Commission (SEC). Registration requires the firm to disclose a great deal
of information before selling any securities. The accounting, legal, and selling costs of
public offerings can be considerable.
Partly to avoid the various regulatory requirements and the expense of public
offerings, debt and equity are often sold privately to large financial institutions such as
life insurance companies or mutual funds. Such private placements do not have to be
registered with the SEC and do not require the involvement of underwriters (investment
banks that specialize in selling securities to the public).
Secondary markets
A secondary market transaction involves one owner or creditor selling to another. It
is therefore the secondary markets that provide the means for transferring ownership of
corporate securities. Although a corporation is only directly involved in a primary market
transaction (when it sells securities to raise cash), the secondary markets are still critical
to large corporations. The reason is that investors are much more willing to purchase
securities in a primary market transaction when they know that those securities can later
be resold if desired.
Dealer versus auction markets
There are two kinds of secondary markets: auction markets and dealer markets.
Generally speaking, dealers buy and sell for themselves, at their own risk. A car dealer,
for example, buys and sells automobiles. In contrast, brokers and agents match buyers
and sellers, but they do not actually own the commodity that is bought or sold. A real
estate agent, for example, does not normally buy and sell houses.
Dealer markets in stocks and long-term debt are called over-the-counter (OTC)
markets. Most trading in debt securities takes place over the counter. The expression over
the counter refers to days of old when securities were literally bought and sold at
counters in offices around the country. Today, a significant fraction of the market for
stocks and almost all of the market for long-term debt have no central location; the many
dealers are connected electronically.
Auction markets differ from dealer markets in two ways. First, an auction market or
exchange has a physical location (like Wall Street). Second, in a dealer market, most of
the buying and selling is done by the dealer. The primary purpose of an auction market,
on the other hand, is to match those who wish to sell with those who wish to buy. Dealers
play a limited role.
Trading in corporate securities
The equity shares of most of the large firms in the United States trade in organized
auction markets. The largest such market is the New York Stock Exchange (NYSE), which
accounts for more than 85 percent of all the shares traded in auction markets. Other
auction exchanges include the American Stock Exchange (AMEX) and regional exchanges
such as the Pacific Stock Exchange.
In addition to the stock exchanges, there is a large OTC market for stocks. In 1971,
the National Association of Securities Dealers (NASD) made available to dealers and
brokers an electronic quotation system called NASDAQ (NASD Automated Quotation
system, pronounced “naz-dak” and now spelled “Nasdaq”). There are roughly two times
as many companies on Nasdaq as there are on NYSE, but they tend to be much smaller
in size and trade less actively. There are exceptions, of course. Both Microsoft and Intel
trade OTC, for example. Nonetheless, the total value of Nasdaq stocks is much less than
the total value of NYSE stocks.
There are many large and important financial markets outside the United States, of
course, and U.S. corporations are increasingly looking to these markets to raise cash. The
Tokyo Stock Exchange and the London Stock Exchange (TSE and LSE, respectively) are
two well-known examples. The fact that OTC markets have no physical location means
that national borders do not present a great barrier, and there is now a huge international
OTC debt market. Because of globalization, financial markets have reached the point
where trading in many investments never stops; it just travels around the world.
Listing
Stocks that trade on an organized exchange are said to be listed on that exchange.
In order to be listed, firms must meet certain minimum criteria concerning, for example,
asset size and number of shareholders. These criteria differ from one exchange to
another
NYSE has the most stringent requirements of the exchanges in the United States.
For example, to be listed on NYSE, a company is expected to have a market value for its
publicly held shares of at least $100 million and a total of at least 2,000 shareholders with
at least 100 shares each. There are additional minimums on earnings, assets, and
number of shares outstanding.
