The Role of Primary and Secondary Money Markets

by Lee Mason ; Updated July 27, 2017

For investors to be able to trade securities, they need access to the assets. Primary and secondary money markets exist to allow investors this access, creating the ability for the purchase and sale of securities. How the security is being offered will determine the market it will be found in. Primary markets are new markets, and secondary markets are resale markets. Understanding how these markets function gives investors better awareness on where to find which security.

Primary Market

Primary markets are markets dealing in the issue of new securities. These can be initial public offerings (IPOs) for public companies, government bonds or other private and public sector funding programs. In a primary market, the security is sold directly to the investor from the company or organization itself. As in the case with IPOs, it is a purchase between the company and the investor. In the case of municipal bonds, it is the purchase of the debenture directly from the municipality. Primary markets are a vital part of the capital markets and underlying strength of the economy.

Secondary Market

Once something has gone through its offering in the primary market, it will then be made available in secondary markets such as stock exchanges and through brokerage firms. There may be a specified period before the issue can be sold on a secondary market to allow it to preserve the strength and integrity of the offering as in cases with IPOs. Once securities are on the aftermarket, they can be bought and sold based on demand. Securities exchanges are the "store" that these securities are sold with sales forces extending through brokerage firms. The information presented on the nightly news with market ups and downs is referring to the secondary markets most often.

Underwriting

For new issues to make it to the primary market, they must go through an underwriting process to ensure that the company making the offering has completed all financial disclosures and has fulfilled all requirements necessary to make the offering. With the offering, investors must be given a prospectus to review all the risks associated with the offering and, in some instances, demonstrate their own ability to assume those risks. IPOs are historically considered high-risk investments.

Market Makers

Market makers are essential in the success of both the primary and secondary markets. These are firms, broker-dealers, that hold a certain number of shares of specific securities to be traded. The firm assumes risk in doing so by investing its own capital to hold the securities to then sell it from its own inventory. Market makers set the spread on prices with the buy sell being either higher or lower than the buy depending on the demand. If the spread is tight, this may mean that supply-demand is not very high for the security and may leave the market maker with inventory sitting for extended periods of time.

Other Markets

There also exist third and fourth markets as well as private markets. Third markets are smaller, marginally funded companies hoping to gain an influx of capital by being on the OTC (over-the-counter market). These are sometimes referred to as pink sheets or penny stocks. The fourth market refers to trading between institutions directly and is also a vital capital market structure. Private markets deal with private equities but are still governed by many rules and regulations that affect all corporate stock investments.

References