## Learning Outcomes

After studying this article, you will be able to distinguish between primary and secondary financial markets, explain how new securities are issued and traded, and describe the importance of these markets in allocating capital. You will also learn the impact of security issuance on businesses and investors, and the core function of financial institutions in connecting borrowers and lenders.

## ACCA Financial Management (FM) Syllabus

For ACCA Financial Management (FM), you are required to understand the structure and roles of financial markets and institutions. Key areas for revision in this article include:

- The distinction between money and capital markets, and their national and international roles
- The function and structure of primary and secondary markets
- The issuance and trading of securities, including new share issues and debt instruments
- The importance of market liquidity and efficient allocation of funds
- The roles of financial intermediaries in connecting investors and entities requiring finance

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. Which market is responsible for the initial sale of new securities to investors?
   a) Primary market
   b) Secondary market
   c) Money market
   d) Commodities market

2. True or false? The main role of the secondary market is to raise new capital for companies.

3. Briefly define the difference between a primary and a secondary market.

4. What is one key advantage to a business of a well-functioning secondary market?

## Introduction

Financial markets are essential mechanisms through which surplus funds are channeled from those who wish to invest to those who require capital for business activities. The structure of these markets—particularly the distinction between primary and secondary markets—determines how new securities are issued and subsequently traded. A clear understanding of these markets is fundamental for the ACCA FM exam, as it underpins how businesses access finance and how investors manage and transfer their investments.

> **Key Term: financial market**
> An organized platform where buyers and sellers trade financial securities, such as shares or bonds, connecting those with surplus funds to those seeking capital.

### PRIMARY MARKETS: ISSUANCE OF NEW SECURITIES

The **primary market** is where new securities are created and sold for the first time. Companies, governments, or other institutions use the primary market to raise funding by issuing shares (equity), bonds (debt), or other instruments.

### Key features (primary market)

- The issuer receives funds directly from the investor.
- Examples include initial public offerings (IPOs), private placements, rights issues, and government bond auctions.
- Helps businesses fund new projects, investments, or expansion.

> **Key Term: primary market**
> The segment of the financial market where new securities are issued and sold directly by the issuer to investors to raise capital.

### Common types of issuance

- **Initial Public Offering (IPO):** First sale of shares to the public by a company.
- **Rights Issue:** Offer of new shares to existing shareholders, usually at a discount.
- **Bond Issue:** Governments or corporations offer new debt instruments to raise funds.

### Worked Example 1.1

Question:
Hogan Ltd decides to raise £10 million by issuing new shares via an IPO. Who provides the funds to Hogan, and what type of market activity is this?

> **Answer:**
> The funds come directly from new investors or institutions buying the shares at the IPO. This is a primary market activity, as Hogan Ltd is issuing new securities to raise capital.

### SECONDARY MARKETS: TRADING OF EXISTING SECURITIES

The **secondary market** is where previously issued securities are bought and sold among investors. No new funds go to the original issuer; instead, ownership of the securities changes hands.

### Key features (secondary market)

- Provides liquidity—investors can buy and sell quickly if needed.
- Establishes ongoing market prices for securities.
- Examples include stock exchanges (e.g., the London Stock Exchange) and bond markets.

> **Key Term: secondary market**
> The segment of the financial market where existing securities are traded between investors, without direct involvement or new funding for the original issuer.

### Importance of the secondary market

- Enhances investor confidence, as securities can be easily sold.
- Helps determine fair pricing through supply and demand.
- Supports primary markets—investors are more willing to buy new securities if they can sell them later.

### Worked Example 1.2

Question:
Amanda purchases 1,000 shares in Peak Energy Ltd on a stock exchange from another investor who wishes to sell. Does Peak Energy Ltd receive any funds from this transaction? What type of market is this?

> **Answer:**
> No, Peak Energy Ltd does not receive money from the sale; the funds go to the investor selling the shares. This transaction occurs in the secondary market.

### RELATIONSHIP BETWEEN PRIMARY AND SECONDARY MARKETS

Primary and secondary markets are closely linked and together support efficient capital allocation:

![Security issuance process from identifying a funding requirement to pricing, investor allocation, and admission for secondary market trading.](https://static.pastpaperhero.com/images/acca-fm-financial-markets-and-institutions-primary-vs-secondary-markets-and-issuance_00.png)

_New securities issuance follows a sequence from financing need and issue method selection to investor allocation and secondary market admission._

- The primary market cannot function well without an active secondary market, which ensures that investors can sell their securities when needed.
- The secondary market provides continuous pricing and information about the value of securities issued in the primary market.

> **Key Term: liquidity**
> The ease with which an asset can be bought or sold in the market without impacting its price.

### THE ROLE OF FINANCIAL INSTITUTIONS

Financial institutions—including investment banks, commercial banks, brokers, and exchanges—facilitate activities in both primary and secondary markets. They:

- Underwrite and distribute new securities (primary market)
- Act as intermediaries or brokers in traded securities (secondary market)
- Support market efficiency, regulation, and investor confidence

> **Key Term: financial intermediary**
> An organization, such as a bank or broker, that connects savers with borrowers and facilitates the trading and transfer of financial assets.

### TYPES OF SECURITIES AND IMPACTS OF MARKET TRADING

Securities traded include shares, bonds, and derivatives. Each issuance and subsequent trading event can influence:

- The firm’s ability to raise further finance (good market liquidity lowers the cost of capital)
- Share price stability and investor perception

### Worked Example 1.3

Question:
Why might a company’s ability to issue new shares at a favourable price depend on the performance of its shares in the secondary market?

> **Answer:**
> Investors will only buy new shares if they expect to be able to sell them later at a similar or higher price. If a company’s shares trade actively and maintain value in the secondary market, investors are more likely to participate in future issuances.
>
> **Exam Warning:**
> Never confuse primary and secondary markets: only the primary market involves the issuer receiving new funds. All subsequent trading is in the secondary market, regardless of whether the investor is buying or selling.
>
> **Revision Tip:**
> Learn the key differences and functions of primary and secondary markets. Practice examples are frequently tested in ACCA FM exams, especially about capital raising and liquidity.

## Summary

- The **primary market** is where new securities are issued and capital is raised.
- The **secondary market** is where existing securities are traded among investors.
- Both markets are essential for efficient allocation of funds and economic growth.
- Active secondary markets encourage investment in new issues by providing liquidity.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Distinguish between primary and secondary financial markets
- Identify how new securities are issued in the primary market
- Explain the role and function of the secondary market in providing liquidity
- Understand the link between both markets for capital allocation and investor confidence
- Describe the role of financial intermediaries

## Key Terms and Concepts

- financial market
- primary market
- secondary market
- liquidity
- financial intermediary


Financial markets and institutions - Primary vs secondary markets and issuance