Primary and Secondary Market

Before discussing about the primary and secondary market, you have to know what actually the financial market is.

Financial market refers to the market where the financial securities (both short-term and long-term), derivative securities and the foreign currencies are traded. Financial market is one of the component of financial system which facilities the trading of financial securities like equity, bonds, debentures etc, derivative securities like option, warrants etc and foreign currencies thereby supporting the industrial development in the national as well as international level.

Now, lets talk about the primary and secondary market in detail.

Primary Market

Primary market is that type of financial market where new securities are traded. The IPO of the company is processed through the primary market. The investor who want to buy fresh securities can buy from the primary market. The issuing company collect needed amount of capital by selling securities in the primary market. The securities traded in primary market may be both short-term and long-term in nature. Investment bankers, underwriters, investors, commercial banks and issuing companies are the players of primary markets.

Secondary Market

Secondary market is that type of financial market where already issued securities are traded. The securities bought in the IPO are traded in secondary market. Secondary Market helps to provide liquidity to the investors by facilitating the trade of already issued securities. Brokers, dealers, buyers and sellers are the main participants of secondary markets. There is no involvement of issuing company in secondary market.

Secondary market is also categorized into two types: Dealer market and Auction market.

Dealer Market

A financial market mechanism wherein multiple dealers post prices at which they are willing to buy or sell a specific security is called dealer market. In a dealer market, a dealer who is designated as a market maker provides liquidity and transparency by electronically displaying the prices at which it is willing to make a market in a security, indicating both the price at which it will buy (the bid price) and the price at which it will sell (the ask price). The government securities market and all OTC markets are dealer market. Dealer market are Quote driven.

For example, if dealer A has ample inventory of ABC co. Stock – which is quoted in the market by other market makers at $100 / $100.5 – and wishes to offload some of its holdings, it can post its bid-ask quote as $99.8 / $100.3. Rational investors looking to buy ABC co. Would then take dealer a’s offer price of $100.3, since it is 20 cents cheaper than the $100.5 price at which it is offered by other market makers. Conversely, investors looking to sell ABC co. Stock would have little incentive to “hit the bid” of $99.8 posted by dealer a, since it is 20 cents less than the $100 price that other dealers are willing to pay for the stock.

Auction Market

A market in which buyers enter competitive bids and sellers enter competitive offers at the same time. On an auction market, the current price for a share in a security is the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. Matching bids and offers are then paired together and the orders are executed. All future markets are auction market. Auction market are Order-driven.

For example, if potential buyers for Security A enter bids of $100, $101, and $102, and potential sellers enter offers of $102, $103, and $104.
In this scenario, only the bids/offers for Security A at $102 will be executed. All remaining orders will not immediately be executed and the current price of security A will then be $102.