Primary Market

Marlow Industries buys 500,000 of its own outstanding shares on an exchange. How is that transaction classified?

1. A.A secondary market transaction, because existing shares change hands between holders.Correct. The shares already existed and were purchased from investors in the open market.
2. B.A primary market transaction, because the issuer itself is a party to the trade.Wrong. The identity of the buyer does not define the market; the creation of new securities does.
3. C.A primary market transaction in reverse, because the shares return to the issuer.Wrong. No such category exists, and the phrasing obscures where the trade actually took place.
4. D.Neither, because a company may not transact in its own securities on an exchange.Wrong. Companies repurchase their own shares regularly, subject to rules on how it must be done.

Why: The primary market is defined by newly issued securities and proceeds flowing to the issuer. A buyback runs the other way: the company pays cash out to shareholders and receives shares that already exist, so it is participating in the secondary market as a buyer. The number of shares outstanding falls, which affects earnings per share and the percentages held by remaining owners, but no capital was raised. Contrast an issuance of new shares to the public, which increases the share count and brings money in.

Ferris Cable offers its existing shareholders the right to buy newly issued shares at a subscription price, and shareholders who exercise send their money to the company. This offering is:

1. A.A primary market transaction, because new shares are issued and the company is paid.Correct. New shares plus proceeds flowing to the issuer is the defining pattern of a primary offering.
2. B.A secondary market transaction, because only existing shareholders may participate.Wrong. Who is eligible to buy does not set the market; what matters is whether the shares are newly created.
3. C.A secondary market transaction, because the rights themselves trade among investors.Wrong. Trading in the rights is a separate secondary market and does not change what the exercise itself is.
4. D.Neither, because no underwriter is distributing the shares to the general public.Wrong. An offering is primary with or without an underwriter, since classification follows the flow of shares and cash.

Why: The primary market is where an issuer sells newly created securities and receives the proceeds. In a rights offering the company issues new shares to shareholders who subscribe and the subscription money goes to the company, so the exercise is squarely a primary transaction. The rights themselves may be listed and traded among investors, and those trades are secondary, but they are a separate matter from the exercise. The company's motive, raising capital while letting existing holders avoid dilution, is precisely what the primary market is for.

An investor sends money to an open-end investment company and receives newly issued shares. In which market did the transaction occur, and who receives the money?

1. A.The secondary market, and the money goes to the shareholder who sold the shares.Wrong. There is no selling shareholder, because the shares did not previously belong to anyone.
2. B.The secondary market, and the money goes to the fund's distributor.Wrong. The distributor is compensated out of any sales charge and is not the recipient of the investment.
3. C.The primary market, and the money goes to the broker executing the order.Wrong. The executing firm earns a concession where one applies, while the invested amount goes to the fund.
4. D.The primary market, and the money goes to the fund itself.Correct. An open-end fund creates new shares on demand, so every purchase is a fresh issuance.

Why: An open-end fund is in a continuous primary offering: it creates new shares whenever an investor buys and cancels them on redemption. Because the shares are newly issued, the money paid becomes part of the fund's portfolio, less any sales charge. Every purchase is therefore a primary market transaction, which is why a prospectus must be delivered even for a routine purchase by a long-standing shareholder. A redemption reverses the flow, with the fund paying the investor out of portfolio assets.

The Treasury sells newly issued notes at auction to primary dealers and other bidders. In which market does that sale occur, and who receives the money?

1. A.The secondary market, and the proceeds go to the Federal Reserve.Wrong. Newly created securities are never a secondary transaction, and the Fed is not the seller in an auction.
2. B.The primary market, and the proceeds go to the Treasury.Correct. The notes are newly issued and the government receives the money it is borrowing.
3. C.The secondary market, and the proceeds go to the dealers who resell the notes.Wrong. Dealers pay for the notes at auction and earn their return by reselling them afterward.
4. D.The primary market, and the proceeds go to the dealers as underwriting compensation.Wrong. There is no underwriting spread in an auction, since bidders buy at the price their own bids establish.

Why: An auction of new Treasury securities is the government's primary market: the securities did not exist before, and the cash raised funds federal borrowing. Once bidders own the notes they resell them to investors, and every one of those later trades is a secondary transaction in which the Treasury receives nothing. The two markets serve different purposes, one raising capital and the other providing liquidity and continuous pricing. The same division applies to corporate bonds sold through a syndicate and then traded over the counter.