The primary market is where securities are sold for the first time. The key feature of any primary market transaction is that the money raised (the proceeds) goes back to the issuer. An initial public offering (IPO), which you’ve seen in earlier chapters, is one example of a primary market transaction. After the issuer raises capital in the primary market, the security can then be traded among investors in the secondary market.
There are four key participants to know when discussing the primary market:
Issuers are companies, organizations, or governments that raise capital by selling securities. Underwriters (often called investment banks) are hired by issuers to market and facilitate the sale of those securities. Investors are the buyers in the primary market. Finally, the Securities and Exchange Commission (SEC) oversees the primary market and regulates the financial professionals who participate in it.
Issuers can be anything from a small start-up to a national government. An issuer raises capital when it identifies a need for funding. That need might include expanding the business, hiring a large number of employees, or covering deficit spending (as governments sometimes do). Real-world examples of issuers include:
Issuers usually need help managing a securities offering. In most cases, they don’t have the network or infrastructure to sell securities directly to investors. Selling new issues also involves many rules and responsibilities, which is why issuers typically rely on specialized financial firms.
Underwriters are hired by issuers to help plan, market, and sell securities to the public. Investment banking (also called underwriting) can be a major business. For example, Facebook’s underwriters made over $100 million during their IPO in 2012. Underwriters can provide general guidance, help set terms for the offering, and participate directly in selling the securities. Real-world examples of underwriters include:
The underwriter associated with an IPO is not the only financial firm involved in the sale. When an issuer hires an underwriter, it typically hires a lead underwriter, who then forms a group called a syndicate.
The syndicate is made up of several financial firms that help the lead underwriter sell the offering. In return for their participation, the lead underwriter shares underwriting fees with syndicate members. The lead underwriter serves as the main point of contact for the issuer, manages the underwriting syndicate, and coordinates the sale of the issue to the public.
Securities sold in the primary market are purchased by investors. Investors can be individuals (like you), financial institutions, or even government entities. The regulations surrounding new issues are designed to protect investors from fraud and manipulation by issuers and underwriters.
When a new issue is offered in the primary market, it will typically be regulated by the SEC. Unless an exemption applies, new issues must be registered. Registration involves substantial paperwork and fees, but its purpose is to ensure the issuer and underwriter provide the public with enough information to make an informed investment decision. We’ll cover this process in more detail later in this unit.
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