What is the essential function of a primary market?

Answer & explanation

Correct answer: option 4

The correct answer is Option (4) → To facilitate the transfer of investible funds from savers to entrepreneurs seeking to establish new enterprises or to expand existing ones

Option (1) To facilitate the transfer of investible funds from existing investors who disinvest to fresh investors who wish to enter the market — Incorrect. This is the role of the secondary market. It helps existing investors to disinvest and fresh investors to enter.

Option (2) To facilitate the transfer of surplus funds from banks with extra cash to banks that need cash for the cash reserve ratio — Incorrect. Banks lend spare cash to each other through call money, a money market instrument, to keep their cash reserve ratio.

Option (3) To facilitate the transfer of savings from households that deposit with banks to business firms that borrow from those banks for their needs — Incorrect. This is the bank route: households deposit savings with banks, and banks lend them to firms. The primary market moves funds through the issue of securities.

Option (4) To facilitate the transfer of investible funds from savers to entrepreneurs seeking to establish new enterprises or to expand existing ones — Correct. The primary market, or new issues market, deals in securities issued for the first time. Through these issues, the funds of savers reach entrepreneurs who set up new enterprises or expand existing ones.

NCERT (Pre-rationalised Edition): “PRIMARY MARKET The primary market is also known as the new issues market. It deals with new securities being issued for the first time. The essential function of a primary market is to facilitate the transfer of investible funds from savers to entrepreneurs seeking to establish new enterprises or to expand existing ones through the issue of securities for the first time. The investors in this market are banks, financial institutions, insurance companies, mutual funds and individuals. …”

“CONCEPT OF FINANCIAL MARKET … There are two major alternative mechanisms through which allocation of funds can be done: via banks or via financial markets. Households can deposit their surplus funds with banks, who in turn could lend these funds to business firms. Alternately, households can buy the shares and debentures offered by a business using financial markets. The process by which allocation of funds is done is called financial intermediation. Banks and financial markets are competing intermediaries in the financial system, and give households a choice of where they want to place their savings. …”

“SECONDARY MARKET … The secondary market is also known as the stock market or stock exchange. It is a market for the purchase and sale of existing securities. It helps existing investors to disinvest and fresh investors to enter the market. It also provides liquidity and marketability to existing securities. …”