Subject 6. Primary Security Markets

The primary markets are those in which new issues of bonds, preferred stock, or common stock are sold by government units, municipalities, or companies to acquire new capital.

  • New issue.
  • Key factor: issuer receives the proceeds from the sale.

There are two important rules in the primary capital markets:

  • Rule 415 allows large firms to register security issues and sell them piecemeal over the following two years. Such issues are called shelf-registration. This rule allows a single registration document to be filed that permits the issuance of multiple securities.
  • Rule 144A allows corporations (including non-U.S. firms) to place securities privately with large, sophisticated investors. The issuer of a private placement reduces issuing costs because it does not have to complete the extensive registration documents. However, investors will require a higher return since no secondary market exists and thus the liquidity risk is high.

New stock issues are divided into two groups:

  • Initial public offerings (IPOs). These are new shares that a firm offers to the public for the first time. They are typically underwritten by investment bankers through negotiated arrangements (the most common form), competitive bids, and best-effort arrangements (investment bankers act as brokers, not taking the price risk).
  • Seasoned equity issues. These are new shares issued by firms that already have stocks outstanding.

A rights issue is an option that a company can opt for to raise capital under a secondary market offering or by using a seasoned equity offering of shares to raise money. It is a special form of shelf offering or shelf registration. With the issued rights, existing shareholders have the privilege of buying a specified number of new shares from the firm at a specified price within a specified time.

Government bond issues are sold at Federal Reserve auctions.

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