B:Primary and secondary markets

B:Primary and secondary markets

1. Primary Market

   • market that issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities. Primary markets are facilitated by underwriting groups, which consist of investment banks that will set a beginning price range for a given security and then oversee its sale directly to investors.
     • Also known as "new issue market" (NIM).

2. Secondary Market

   • A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges - such as the New York Stock Exchange and the NASDAQ are secondary markets. Secondary markets exist for other securities as well, such as when funds, investment banks, or entities such as Fannie Mae purchase mortgages from issuing lenders. In any secondary market trade, the cash proceeds go to an investor rather than to the underlying company/entity directly.
   • CHARACTERISTICS OF SECONDARY MARKET
     • Diversification
       • A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.
         • Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.
     • Risk shifting
       • Deficit units, particularly companies, issue various types of security on the financial markets to give investors a choice of the degree of risk they take. For example company loan stocks secured on the assets of the business offer low risk with relatively low returns, whereas equities carry much higher risk with correspondingly higher returns.
     • Hedging
       • Financial markets offer participants the opportunity to reduce risk through hedging, which involves taking out counterbalancing contracts to offset existing risks,
         • e.g. if a UK exporter is awaiting payment in euros from a French customer he is subject to the risk that the euro may decline in value over the credit period. To hedge this risk he could enter a counterbalancing contract and arrange to sell the euros forward (agree to exchange them for pounds at a fixed future date at a fixed exchange rate). In this way he has used the foreign exchange market to insure his future sterling receipt. Similar hedging possibilities are available on interest rates (see chapter 14).
     • Arbitrage
       • Arbitrage is the process of buying a security at a low price in one market and simultaneously selling in another market at a higher price to make a profit.
         • Although it is only the primary markets that raise new funds for deficit units, well developed secondary markets are required to fulfil the above roles for lenders and borrowers. Without these opportunities more surplus units would be tempted to keep their funds ‘under the bed’ rather than putting them at the disposal of deficit units.
           • However, the emergence of disintermediation (reduction in the use of intermediaries) and securitisation (conversion into marketable securities), where companies lend and borrow funds directly between themselves, has provided a further means of dealing with cash flow surpluses and deficits.