Another method that is used to issue new instruments is known as the "tap" method, whereby not all the shares or bonds are allocated at the first issue through any of the above three methods. If, for instance, the company or borrower wants to issue N1,000,million worth of shares or bonds he can choose to issue only N600 million at the first issue. The borrower or intermediary then starts creating a secondary market for these instruments by buying and selling the issued instruments in the secondary market. This process, where one party buys and sells the same instrument in the market, is known as market making.
The market maker thus has a bid (to buy) and an offer (to sell) in the market for the same instrument, trying to create an active and liquid market in this instrument. The "tap"
method is then used by the borrower or intermediary, whereby more instruments are sold in the market than that bought back. By using this method, the amount of the issue is increased, often without the market realising it.
73
This method can also be used in inverse form to decrease the total outstanding loan. The ultimate user of the funds from the securities in the capital market can use the tap method, because the company is allowed to trade in its own securities. This is possible in the equities market because a company is allowed to buy its own shares.
SELF-ASSESSMENT EXERCISE 5
Mention and explain the methods of issuing new securities.
3.3. SECONDARY MARKET
In the secondary markets, existing securities are sold and bought among investors or traders, usually on a stock exchange, characterized by over-the counter, or operated electronically in highly developed economies. The existence of secondary markets increases the willingness of investors in primary markets, as they know they are likely to be able to swiftly cash out their investments if the need arises.
Transactions in secondary markets: Most capital market transactions are executed electronically, but in less developed stock exchanges sometimes traders are directly involved and sometimes unattended computer systems in highly developed stock exchanges execute the transactions, such as in algorithmic trading system.
Most capital market transactions take place on the secondary market. On the primary market, each security can be sold only once, and the process to create batches of new shares or bonds is often lengthy due to regulatory requirements.
On the secondary markets, there is no limit on the number of times a security can be traded, and the process is usually very quick. With the rise of strategies such as highly frequency trading, a single security could in theory be traded thousands of times within a single hour.
Transactions on the secondary market don't directly help raise finance, but they do make it easier for companies and governments to raise finance on the primary market, as investors know if they want to get their money back in a hurry, they will usually be easily able to re-sell their securities.
Sometimes secondary capital market transactions can have a negative effect on the primary borrowers - for example, if a large proportion of investors try to sell their bonds, this can push up the yields for future issues from the same entity.In modern time, several governments have tried to avoid as much as possible the penchant for borrowing into long dated bonds, so they are less vulnerable to pressure from the markets.
A variety of different players are active in the secondary markets. Regular individuals account for a small proportion of trading, though their share has slightly increased; in the
74
20th century it was mostly only a few wealthy individuals who could afford an account with a broker, but accounts are now much cheaper and accessible over the internet.
There days there are now numerous small traders who can buy and sell on the secondary markets using platforms provided by brokers which are accessible with web browsers.
When such an individual trades on the capital markets, it will often involve a two stage transaction. First they place an order with their broker, then the broker executes the trade.
If the trade can be done on an exchange, the process will often be fully automated. If a dealer needs to manually intervene, this will often mean a larger fee.
Traders in investment banks will often make deals on their bank's behalf, as well as executing trades for their clients. Investment banks will often have a department called capital markets: staff in this department try to keep aware of the various opportunities in both the primary and secondary markets, and will advise major clients accordingly.
Pension and Sovereign wealth funds tend to have the largest holdings, though they tend to buy only the highest grade (safest) types of bonds and shares, and often don't trade all that frequently.
SELF-ASSESSMENT EXERCISE 6
Differentiate between primary market and secondary market.
3.4 CAPITAL MARKET INSTRUMENTS & SECURITIES 3.4.1CAPITAL MARKET INSTRUMENTS
The principal capital market instruments used for long term funds include the following:
(i) Mortgages.
(ii) Corporation bonds.
(iii) State and local government bonds.
(iv) Federally sponsored credit agency securities.
(v) Finance company bonds.
(vi) Commercial banks bonds and commercial paper.
(viii) Corporate stock.
Capital market instrumentsare fixed-income obligations that trade in the secondary market, which means anyone can buy and sell them to other individuals or institutions.Marketable securities are exchanged through the organized markets for example, stock exchanges and its Representative dealers and brokers who sell and buy marketable securities on behalf of their customer in exchange of commission.
75
Therefore, the capital market instruments fall into four categories such as: Treasury securities; government agency securities; municipal bonds; and corporate bonds.