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Overview of Financial Markets

primary market

A financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction.

initial public offering (IPO)

A firm's first offering of stock to the public.

secondary offering

Any offering of stock subsequent to an initial public offering.

secondary market

A financial market in which securities that are already owned (those that are not new issues) are traded.

Financial markets are crucial for firms and investors because they facilitate the transfer of funds between the investors who wish to invest and firms that need to obtain funds. Second, they can accommodate the needs of firms that temporarily have excess funds and wish to invest those funds. Third, they can accommodate the needs of investors who wish to liquidate their investments in order to spend the proceeds or invest them in alternative investments.

Primary versus Secondary Markets

Debt and equity securities are issued by firms in the primary market, the market that facilitates the issuance of new securities. The first offering of stock to the public is referred to as an initial public offering (IPO). Any offering of stock by the firm after that point is referred to as a secondary offering. Once securities have been issued, they can be sold by investors to other investors in the so-called secondary market, the market that facilitates the trading of existing securities. The distinction between the primary market and the secondary market is illustrated in the following example.

EXAMPLE

Kenson Co. was established in Jacksonville, Florida, in July 1981. It enjoyed success as a privately held firm for more than 10 years, but it could not grow as much as desired because of a constraint on the amount of loans it could obtain from commercial banks. In order to expand its business throughout the southeastern United States, Kenson needed a large equity investment from other firms. On March 13, 1992, it engaged in an initial public offering. With the help of a securities firm, it was able to issue 2 million shares of stock on that day at an average price of $20 per share. Thus the company raised a total of $40 million. As investors in Kenson's stock later decided to sell it, they used the secondary market to sell the stock to other investors. The secondary market activity does not directly affect the amount of existing funds that Kenson has available to support its expansion. That is, Kenson gets no additional funds when investors sell their shares in the secondary market.

Kenson's expansion throughout the Southeast over the next several years was successful, and it decided to expand across the United States. By this time, its stock price was near $60 per share. On June 7, 2000, Kenson engaged in a secondary stock offering by issuing another 1 million shares of stock. The new shares were sold at an average price of $60, thereby generating $60 million for Kenson to pursue its expansion plans. After that date, some of the new shares, as well as shares that resulted from the IPO, were traded in the secondary market. The evolution of Kenson's financing is shown in Figure 2.

 
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