Question

Respond to the following in a minimum of 175 words:

Share how you would describe the overall purpose and mechanics of both primary and secondary markets.

How would you explain the way the performance of your company is influenced by the activity of the markets you described?

After your initial post, choose a classmate’s approach that is different from the approach you’d take on the guest lecture. What additional information might you include in your lecture based on your classmate’s approach?

Answer 1

The term capital market refers to any part of the financial system that raises capital from bonds, shares, and other investments. New stocks and bonds are created and sold to investors in the primary capital market, while investors trade securities on the secondary capital market.

Primary Capital Market

When a company publicly sells new stocks and bonds for the first time, it does so in the primary capital market. This market is also called the new issues market. In many cases, the new issue takes the form of an initial public offering (IPO). When investors purchase securities on the primary capital market, the company that offers the securities hires an underwriting firm to review it and create a prospectus outlining the price and other details of the securities to be issued.

All issues on the primary market are subject to strict regulation. Companies must file statements with the Securities and Exchange Commission (SEC) and other securities agencies and must wait until their filings are approved before they can go public.

Companies that issue securities through the primary capital market may hire investment bankers to obtain commitments from large institutional investors to purchase the securities when first offered. Small investors are often unable to buy securities at this point because the company and its investment bankers want to sell all of the available securities in a short period of time to meet the required volume, and they must focus on marketing the sale to large investors who can buy more securities at once.Prices are often volatile in the primary market because demand is often hard to predict when a security is first issued. That's why a lot of IPOs are set at low prices.

Secondary Capital Market

The secondary market is where securities are traded after the company has sold its offering on the primary market. It is also referred to as the stock market. The New York Stock Exchange (NYSE), London Stock Exchange, and Nasdaq are secondary markets.

Small investors have a much better chance of trading securities on the secondary market since they are excluded from IPOs. Anyone can purchase securities on the secondary market as long as they are willing to pay the asking price per share.

A broker typically purchases the securities on behalf of an investor in the secondary market. Unlike the primary market, where prices are set before an IPO takes place, prices on the secondary market fluctuate with demand. Investors will also have to pay a commission to the broker for carrying out the trade.

The volume of securities traded varies from day to day, as supply and demand for the security fluctuates. This also has a big effect on the security's price.

The secondary market has two different categories: the auction and the dealer markets. The auction market is home to the open outcry system where buyers and sellers congregate in one location and announce the prices at which they are willing to buy and sell their securities. The NYSE is one such example. In dealer markets, though, people trade through electronic networks. Most small investors trade through dealer markets.

How the activity of the markets will influence the performance of your company :

The stock market's movements can impact companies in a variety of ways. The rise and fall of share price values affects a company’s market capitalization and therefore its market value. The higher shares are priced the more a company is worth in market value and vice versa. The market value of a company can be important when considering mergers and/or acquisitions that involve shares as part of the deal.

Share issuance decisions can also be affected by stock performance. If a stock is doing well, a company might be more inclined to issue more shares because they believe they can raise more capital at the higher value.

Stock market performance also affects a company’s cost of capital. Company’s must average the costs of both their debt and equity capital when arriving at a weighted average cost of capital which is used for many analysis scenarios. The higher the expected market performance, the higher the cost of equity capital will be. As cost of equity capital rises into the future, present value calculations become lower because companies must use a higher discounting rate.

Companies may also have substantial capital investments in their stock which can lead to problems if the stock falls. For example, companies may hold shares as cash equivalents or use shares as backing for pension funds. In any case, when shares fall, the value decreases which can lead to funding problems.

Lastly, positive increases in stock values can also potentially generate new interests for a particular company or sector. This can possibly add to revenue growth from sales or attract investors.

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