Secondary Market

An investor buys shares of a closed-end fund on an exchange from another investor. How much of the purchase price reaches the fund itself?

1. A.The full purchase price, because the fund issued those shares in the first place.Wrong. The fund was paid when the shares were first issued, and that transaction closed long ago.
2. B.None of it, because the money passes from one investor to another.Correct. Exchange purchases of closed-end shares are secondary market trades between two investors.
3. C.The purchase price less the broker's commission, which the fund retains.Wrong. The commission belongs to the executing firm, and none of the price reaches the fund in any case.
4. D.An amount equal to the fund's net asset value per share purchased.Wrong. Net asset value measures what the portfolio is worth; it is not a payment made to the fund.

Why: A closed-end fund raises capital once, in an offering of a fixed number of shares, and the money it received then is the money it invests. After that its shares trade among investors on an exchange, exactly like the shares of an operating company. Those trades are secondary market transactions, so the fund's asset base is untouched by them and its share price is set by supply and demand rather than by net asset value. Contrast an open-end fund, where every purchase sends new money to the fund itself.

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.

The primary market is where:

1. A.New securities are sold for the first timeCorrect - primary = issuance.
2. B.The Fed sets ratesThis confuses the securities markets with monetary policy. The Fed sets its policy rate and buys or sells existing government securities in the open market; it does not float new issues for corporations.
3. C.Investors trade existing shares with each otherThis is the definition of the secondary market, the classic reversal of the pair. Its distinguishing feature is that proceeds go to the selling investor; in the primary market the proceeds go to the issuer.
4. D.Only bonds tradeAsset class is not what separates primary from secondary. The primary market covers any first-time sale by an issuer, including stock IPOs and additional equity offerings as well as new bond issues.

Why: The primary market is where new securities are sold for the first time (e.g., an IPO); the secondary market is investor-to-investor trading.

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.