I. define primary and secondary markets and explain how secondary markets support primary markets;

Question 1

Primary Markets: the markets in
which companies raise new capital
from investors by issuing (selling)
securities

Answer 1

New issues of securities are sold in primary capital markets

In an underwritten offering, the investment bank guarantees that the issue will be sold at a price that is negotiated between the issuer and bank.

Shelf Registration: A firm makes public disclosures in a regular offering but issue registered securities over time when it needs capital and when markets are favorable.

Dividend Reinvestment Plan: Allows shareholders to reinvest div’s into new shares sold at a discount.

Rights offering: Existing shareholders are given the right to buy new shares at a discount to the current market price, but this dilutes ownership.

In a best efforts offering, the bank acts only as a broker.

In a private placement, a firm sells securities directly to qualified investors, without the disclosures of a public offering.

Proceeds from the sale in the primary market go to the issuing firm

The underwriter provides the following services to the issuer: Origination, which involves the design, planning, and registration of the issue.
Risk bearing, which means the underwriter guarantees the price by purchasing the securities.
Distribution, which is the sale of the issue.

Question 2

Secondary Markets: the markets in

which seasoned issues trade. (secondary markets provide liquidity and price/value info)

Answer 2

Secondary financial markets are where securities trade after their initial issuance.

A liquid secondary market makes it easier for firms to raise external capital in the primary market, which results in a lower cost of capital for firms.

Proceeds from a sale in the secondary market go to the current owner who is selling the securities.

Prevailing market prices are determined by primary market transactions and are used in pricing new issues.

Better is easier to raise capital and easy capital raising means lower cost.

Question 3

Relation Between Primary and Secondary Markets

Answer 3

Secondary markets support the capital
raising process.
• Investors are more willing to invest in
securities that can be sold when they
need cash.

Secondary markets are important because they provide liquidity and continuous information to investors. The liquidity of the secondary markets adds value to both the investor and firm because more investors are willing to buy issues in the primary market, when they know these issues will later become liquid in the secondary market. Therefore, the secondary market makes it easier for firms to raise external capital.