Firms raise capital from investors by issuing shares in the primary markets. Does this imply that...

Firms raise capital from investors by issuing shares in the primary markets. Does this imply that corporate financial managers can ignore trading of previously issued shares in the secondary market?

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Expert Solution

Shares are always issued in the primary market. Investors owning those shares can buy or sell shares with other potential investors in the secondary market. The secondary market trading cannot be ignored as it gives a indication of the firm's share value as perceived in the market.

For example, if the firm issue a share at face value $10. This share is purchased by an investor who after one year is ready to sell it to someone else in the secondary market. Whether he is able to sell the share at a profit depends on the share's perceived value in the eyes of other investors. This depends on what the firm has done within one years' time i.e. awarded some govt. contracts/ acquired a new business/ expanded in other areas/ announced dividend payout to investors. All such news increase the value of the shares in the secondary market. This creates a demand for the share and investors are willing to purchase it at a higher price than $10. So, such trading activities cannot be ignored as they give an indication of firm's shares demand in the market.

jeff jeffy answered 1 year ago

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