SkarpChapter 4 of 27
Primary vs Secondary Markets and Market Structure
Follow a security from its first sale to the ongoing trading that sets its price, and unpack how exchanges, OTC markets, and trading venues fit together.
Following a Security: From Birth to Everyday Trading
The Security's Journey
Follow a single security (like a share of common stock) from its first sale to investors through its life in the markets to understand primary vs secondary markets.
Key Players Refresher
Issuers need capital, investors supply it, and broker-dealers stand in between. SROs like FINRA and exchanges set and enforce rules under SEC oversight.
Broker-Dealer Definition
A broker-dealer is "A firm in the business of buying and selling securities either for the accounts of others (broker) or for its own account (dealer), or both..."
SRO Definition
A self-regulatory organization is "A non-governmental entity, such as FINRA or a national securities exchange, that is registered with and overseen by the SEC..."
Primary vs Secondary Timeline
First sale from issuer to investors happens in the primary market. Later trades between investors, whether on exchanges or OTC, happen in the secondary market.
What You Need for the SIE
You must distinguish primary vs secondary, recognize examples like IPOs and OTC trading, and explain how broker-dealers link issuers and investors at each stage.
Primary Market: Where Securities Are Born
Primary Market Definition
The primary market is "The market in which new securities are issued and sold for the first time... to raise capital for issuers." The issuer gets the money.
Who Is Involved?
Key players: the issuer, underwriters (investment banks/broker-dealers), and investors who buy the new issue and provide capital.
IPO Basics
In an IPO, a private company sells registered shares to the public for the first time. Underwriters price and distribute the new shares.
Follow-On Offerings
A seasoned or follow-on offering is a new share issue by a company that is already public. It is still primary because the issuer gets the proceeds.
Private Placements
Private placements sell securities directly to a small group of sophisticated investors, often under Regulation D exemptions, with less public disclosure.
Exam Tip: Follow the Money
To classify a transaction, ask: Who gets the money? New issue, money to issuer = primary. Investor-to-investor trade, money to seller = secondary.
Primary Market in Action: IPOs and Private Placements
Scenario 1: TechNova's IPO
TechNova hires underwriters, files with the SEC, prices at $20 per share, and sells 20 million new shares to the public. Net proceeds go to TechNova.
IPO Cash Flows
Investors pay $400M total. Underwriters keep a spread; the rest (around $384M) goes to TechNova. New shares + cash to issuer = primary market.
Scenario 2: City Revenue Bonds
A city issues $50M of municipal revenue bonds via private placement to three insurance companies, working with a municipal securities dealer.
Private Placement Features
No broad public marketing; a small group of institutions negotiates and buys the entire new issue directly from the issuer.
Same Market, Different Style
Despite differences in publicity and process, both the IPO and the private placement are primary market deals: new securities, proceeds to issuer.
SIE Angle
On the exam, do not confuse public vs private with primary vs secondary. A deal can be private and still clearly primary if it creates new securities.
Secondary Market: Where Prices Are Discovered
Secondary Market Definition
The secondary market is "The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading."
What Changes Hands?
Previously issued securities move from one investor to another. The issuer usually does not receive any money from these trades.
Why Secondary Markets Matter
They provide liquidity so investors can buy and sell, and they enable price discovery as trades reveal what buyers will pay and sellers will accept.
TechNova After the IPO
When Investor A sells 100 TechNova shares at $22 to Investor B, A gets $2,200, B gets the shares, and TechNova gets nothing. That is secondary.
Venues: Exchange and OTC
Secondary trading occurs on exchanges like NYSE and Nasdaq and in OTC markets where broker-dealers negotiate or use electronic systems.
Exam Trap: "Secondary Offering"
On the exam, focus on who owned the shares and who gets the money. Already issued shares sold by a shareholder are economically secondary.
Public Offerings vs Private Placements
Public Offerings
Public offerings are registered with the SEC, use a prospectus, are broadly marketed, and are open to retail and institutional investors.
Examples of Public Offerings
IPOs, follow-on stock offerings, and large public bond deals are classic public offerings in the primary market.
Private Placements Basics
Private placements rely on registration exemptions, target a small group of sophisticated investors, and involve less public marketing.
Who Buys Private Placements?
Typically accredited investors and institutions like VC funds, insurance companies, and pensions, not the general retail public.
Choosing Between Them
Issuers use public offerings for broad access and liquidity, and private placements for speed, flexibility, and confidentiality.
Exam Distinction
Public vs private is about marketing and investor base. Primary vs secondary is about new vs existing securities and who receives the money.
Market Structure: Exchanges, OTC, and Trading Venues
Exchanges as Venues
Exchanges like NYSE and Nasdaq are SEC-registered national securities exchanges, operate order books, and act as self-regulatory organizations.
Listed Securities
Companies must meet listing standards to trade on an exchange. Their shares are then bought and sold through the exchange's systems.
OTC Market Basics
In OTC markets, broker-dealers quote prices and trade directly. Many corporate bonds, municipal securities, and smaller stocks trade OTC.
Quotation Systems
OTC equity quotes are organized on platforms like OTC Markets tiers and FINRA quotation systems, which are not national exchanges.
ATSs and Dark Pools
Alternative Trading Systems, including dark pools and ECNs, are electronic matching platforms registered as broker-dealers, not as exchanges.
SIE Focus
Remember: exchanges are centralized SROs; OTC is dealer-driven; ATS/ECNs are electronic venues for secondary trading of existing securities.
Broker-Dealers in Primary and Secondary Markets
Broker-Dealer Recap
A broker-dealer is "A firm in the business of buying and selling securities" either for customers as broker, or for itself as dealer, under federal and SRO rules.
Primary Market Role
In the primary market, broker-dealers act as underwriters, helping issuers structure, price, and distribute new issues to investors.
Underwriting Types
Firm commitment: underwriter buys the whole issue and resells it. Best efforts: underwriter only tries to sell; issuer keeps more risk.
Secondary Market Role
In the secondary market, broker-dealers act as brokers (for a commission) or dealers/market makers (trading from inventory for a spread).
Margin Accounts
A margin account is "A customer account in which a broker-dealer lends the customer a portion of the purchase price of securities..." with collateral and limits.
Exam Keyword Cues
Underwriter → primary. Market maker, dealer spread, order routing → secondary. Use these cues to classify questions quickly.
Classify the Scenario: Primary or Secondary? Public or Private?
How to Use This Exercise
For each scenario, decide: 1) primary or secondary market? 2) public offering, private placement, or secondary trading? Answer before reading the check.
Scenario A: Follow-On Shares
Listed biotech issues new registered shares via underwriters to the public. Answer: Primary market, public offering.
Scenario B: Founder Sells
Founder sells 500,000 existing shares via a broker-dealer to institutions. Answer: Secondary market, private block trade/resale.
Scenario C: Reg D Bonds
Manufacturer sells new bonds to three insurance companies under Reg D. Answer: Primary market, private placement.
Scenario D: Retail Order
Retail investor buys 50 shares on NYSE from another investor. Answer: Secondary market, exchange trading venue.
Pattern Recognition
Notice the pattern: new issue + money to issuer = primary; existing securities traded between investors = secondary, regardless of public vs private.
Check Understanding: Primary vs Secondary Basics
Answer this SIE-style question.
Which of the following best describes a transaction in the secondary market?
- A corporation sells newly issued common stock to the public through an underwriting syndicate.
- A municipality sells new revenue bonds directly to three insurance companies under a Regulation D exemption.
- An existing shareholder sells previously issued shares of a public company to another investor on an exchange.
- A private company sells preferred stock to a venture capital fund in a private placement.
Show Answer
Answer: C) An existing shareholder sells previously issued shares of a public company to another investor on an exchange.
The secondary market is "The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading." Only option C describes previously issued shares being traded between investors on an exchange. Options A, B, and D all involve issuers selling new securities in the primary market, whether through public offerings or private placements.
Check Understanding: Venues and Participants
Test your knowledge of market structure and broker-dealers.
In which situation is a broker-dealer MOST clearly acting in the primary market?
- Acting as a market maker in an actively traded stock on Nasdaq.
- Underwriting a new issue of municipal securities for a city government.
- Executing a customer’s order to buy 100 shares on the NYSE.
- Quoting bid and ask prices for a corporate bond in the OTC market.
Show Answer
Answer: B) Underwriting a new issue of municipal securities for a city government.
Underwriting a new issue of municipal securities is a primary market activity because the broker-dealer is helping the issuer sell new securities and raise capital. Acting as a market maker, executing customer orders on the NYSE, and quoting OTC bond prices all involve trading previously issued securities in the secondary market.
Key Term Review: Markets and Structure
Flip through these cards to reinforce core definitions and distinctions.
- primary market
- The market in which new securities are issued and sold for the first time, such as through public offerings and private placements, to raise capital for issuers.
- secondary market
- The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading.
- broker-dealer
- A firm in the business of buying and selling securities either for the accounts of others (broker) or for its own account (dealer), or both, and subject to registration and regulation under federal securities laws and SRO rules.
- self-regulatory organization (SRO)
- A non-governmental entity, such as FINRA or a national securities exchange, that is registered with and overseen by the SEC and is responsible for regulating the practices of its members through the adoption and enforcement of rules.
- public offering
- A primary market sale of new securities to the broad investing public, typically registered with the SEC and distributed via underwriters using a prospectus.
- private placement
- A primary market sale of new securities directly to a limited number of sophisticated or institutional investors, relying on registration exemptions such as Regulation D.
- exchange
- A centralized trading venue, such as NYSE or Nasdaq, registered with the SEC as a national securities exchange and operating as a self-regulatory organization for listed securities.
- over-the-counter (OTC) market
- A decentralized market where broker-dealers quote prices and trade securities directly with each other or with customers, commonly used for many bonds, municipal securities, and smaller-company stocks.
- Alternative Trading System (ATS)
- An SEC-regulated electronic trading platform, often registered as a broker-dealer, that matches buy and sell orders but is not a national securities exchange.
- margin account
- A customer account in which a broker-dealer lends the customer a portion of the purchase price of securities, with the securities and other assets in the account serving as collateral, subject to initial and maintenance margin requirements.
Bringing It Together: Tracing One Security End-to-End
Step 1: Capital Need
A corporation needs $300M to build a new plant and works with a broker-dealer to issue new common stock. This sets up a primary market transaction.
Step 2: Primary Offering
Through an IPO or follow-on public offering, underwriters sell new shares to investors. Cash (net of fees) flows to the issuer: clearly primary market.
Step 3: Listing and Trading
Once listed on an exchange, investors trade the shares among themselves. These are secondary market trades on a national securities exchange.
Step 4: Multiple Venues
Large blocks may trade on ATSs or dark pools, while other orders go to exchanges. All of this is still secondary trading in previously issued shares.
Step 5: New Bonds Later
Years later, the company privately places new bonds with institutions. That new bond sale is primary; subsequent bond trading OTC is secondary.
SIE Readiness Check
If you can track who gets the money, identify venues, and name the broker-dealer's role, you are well prepared for SIE questions on market structure.
Key Terms
- exchange
- A centralized trading venue, such as the New York Stock Exchange (NYSE) or Nasdaq, registered with the SEC as a national securities exchange and operating as a self-regulatory organization.
- common stock
- An equity security representing ownership in a corporation, typically providing voting rights and a residual claim on corporate earnings and assets after creditors and preferred shareholders.
- broker-dealer
- A firm in the business of buying and selling securities either for the accounts of others (broker) or for its own account (dealer), or both, and subject to registration and regulation under federal securities laws and SRO rules.
- margin account
- A customer account in which a broker-dealer lends the customer a portion of the purchase price of securities, with the securities and other assets in the account serving as collateral, subject to initial and maintenance margin requirements.
- primary market
- The market in which new securities are issued and sold for the first time, such as through public offerings and private placements, to raise capital for issuers.
- preferred stock
- An equity security that represents ownership in a corporation and typically pays a fixed dividend, with priority over common stock in dividend payments and liquidation, but usually with limited or no voting rights.
- public offering
- A primary market sale of new securities to the broad investing public, typically registered with the SEC and distributed via underwriters using a prospectus.
- secondary market
- The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading.
- private placement
- A primary market sale of new securities directly to a limited number of sophisticated or institutional investors, relying on registration exemptions such as Regulation D.
- municipal securities
- Debt securities issued by states, municipalities, or their agencies and authorities, including general obligation and revenue bonds, often offering interest that is exempt from federal income tax.
- self-regulatory organization
- A non-governmental entity, such as FINRA or a national securities exchange, that is registered with and overseen by the SEC and is responsible for regulating the practices of its members through the adoption and enforcement of rules.
- over-the-counter (OTC) market
- A decentralized market where broker-dealers quote prices and trade securities directly with each other or with customers, commonly used for many bonds, municipal securities, and smaller-company stocks.
- Alternative Trading System (ATS)
- An SEC-regulated electronic trading platform, often registered as a broker-dealer, that matches buy and sell orders but is not a national securities exchange.