The primary market is where securities are created. It's in this market that firms sell new stocks and bonds to the public for the first time. An initial public offering, or IPO, is an example of a primary market. An IPO occurs when a private company issues stock to the public for the first time.
Companies and government entities sell new issues of common and preferred stock, corporate bonds and government bonds, notes, and bills on the primary market to fund business improvements or expand operations. Although an investment bank may set the securities' initial price and receive a fee for facilitating sales, most of the funding goes to the issuer. Investors typically pay less for securities on the primary market than on the secondary market.
Other types of primary market offerings for stocks include private placement and preferential allotment. Private placement allows companies to sell directly to more significant investors such as hedge funds and banks without making shares publicly available. While preferential allotment offers shares to select investors at a special price not available to the general public.
Similarly, businesses and governments that want to generate debt capital can choose to issue new short- and long-term bonds on the primary market. New bonds are issued with coupon rates that correspond to the current interest rates at the time of issuance, which may be higher or lower than pre-existing bonds.
Companies can raise capital for their business cost-effectively and seamlessly in a primary market. Also, securities offered in the primary market can almost be instantly sold in the secondary market, thus providing high liquidity.
As compared to secondary market, there are less chances of price manipulation in the primary market. This leads to better transparency and operations.
Primary market serves as a potential avenue for diversification for investors, thus bringing down the quantum of risk. Investors can allocate their investments across asset classes in multiple financial instruments.
When you invest in the stocks, keep an eye on the primary market too. This is because IPOs can have great potential to offer big returns to investors. No wonder there is a lot of excitement around each IPO announcement.