When issuers first sell their securities to investors, practitioners say that the trades take place in the primary markets.
An issuer makes an initial public offering (IPO)—sometimes called a placing—of a security issue when it sells the security to the public for the first time.
A seasoned security is a security that an issuer has already issued. If the issuer wants to sell additional units of a previously issued security, it makes a seasoned offering (sometimes called a secondary offering).
Both types of offerings occur in the primary market where issuers sell their securities to investors. Later, if investors trade these securities among themselves, they trade in secondary markets. This section discusses primary markets and the procedures that issuers use to offer their securities to the public.
Public Offerings
Corporations generally contract with an investment bank to help them sell their securities to the public. The investment bank then lines up subscribers who will buy the security. Investment bankers call this process book building.
When time is of the essence, issuers in Europe may issue securities through an accelerated book build, in which the investment bank arranges the offering in only one or two days. Such sales often occur at discounted prices.
In an underwritten offering—the most common type of offering—the investment bank guarantees the sale of the issue at an offering price that it negotiates with the issuer. If the issue is undersubscribed, the bank will buy whatever securities it cannot sell at the offering price. In the case of an IPO, the underwriter usually also promises to make a market in the security for about a month to ensure that the secondary market will be liquid and to provide price support, if necessary. For large issues, a syndicate of investment banks and broker–dealers helps the lead underwrite build the book. The issuer usually pays an underwriting fee of about 7 percent for these various services. The underwriting fee is a placement cost of the offering.
In a best efffort offering, the investment bank acts only as broker. If the offering is undersubscribed, the issuer will not sell as much as it hoped to sell.
Private Placements and Other Primary Market Transections
Corporations sometimes issue their securities in private placements. In a private placement, corporations sell securities directly to a small group of qualified investors, usually with the assistance of an investment bank.
Corporations sometimes sell new issues of seasoned securities directly to the public on a piecemeal basis via a shelf registration. In a shelf registration, the corporation makes all public disclosures that it would for a regular offering, but it does not sell the shares in a single transaction. Instead, it sells the shares directly into the secondary market over time, generally when it needs additional capital. Shelf registrations provide corporations with flexibility in the timing of their capital transactions, and they can alleviate the downward price pressures often associated with large secondary offerings.
Importance of Secondary Markets to Primary Markets
In a liquid market, traders can buy or sell with low transaction costs and small price concessions when they want to trade.
