Capital Markets and Players
By now, you’re getting a good picture of what products are available in the financial world, how you can invest in these products, and the degree of risk that is generally associated with these types of investments. Now, let’s take a step back and look at the different types of markets such as the primary market and the secondary market, and the regulatory agencies that protect you, the financial consumer, from being manipulated.
These markets are responsible for issuing new securities on an exchange. For example, an Initial Public Offering (IPO) will be issued through these markets and facilitated by underwriters, who will set an initial price for the given security and then supervise its direct sale to investors. IPOs occur when a private company decides to sell stocks to the public for the first time.
Essentially, this is the market where securities are created and purchased directly from an issuing company. The primary market can also be referred to as the New Issue Market (NIM).
The Function of IPOs
Primary issues are issued by companies for the purpose of obtaining additional capital in order to expand or modernize the existing business. This means selling off parts of their own company with the total percentage varying per IPO.
For example, when Facebook launched its IPO in May 2012, it wanted to ensure that early investors would retain control of the company while raising $5 billion. Ultimately, underwriters (the key players in the primary market) settled on a price of $38 a share, valuing the company at $104 billion. The stock debuted at 421 million shares, totaling around 15% of the company. Ultimately, it raised closer to $16 billion.
Additionally, the primary market is the place where an issuer already trading can raise additional capital through season equity offering (SEO). This is done either with shares sold by existing shareholders (non-dilutive), new shares (dilutive) or a combination of both.
Quick Overview of the Players and Terms
i. Underwriters: The entities that ultimately decide the opening price of the stocks at the IPO and thus decide the initial valuation of the company in question
ii. Issuer: The company offering the new securities.
iii. Brokers: These guys handle the distribution of the new securities to investors. Brokers generally have established a relationship with these investors over time.
ii. Initial Public Offering: The first offering of a private company’s stock to the public, thus turning it into a public company