Final answer:
The primary market is where new securities are issued, while the secondary market is for trading existing securities amongst investors. The value of bonds in the secondary market can fluctuate with changes in market interest rates. A bond's present value, which takes into account its face value, coupon rate, maturity date, and market rates, determines its current price in the secondary market.
Step-by-step explanation:
The primary market is where securities are created, with firms selling new stocks and bonds to the public for the first time, such as through initial public offerings (IPOs). The primary market allows only the original issuer to redeem or purchase the asset when it is sold. Meanwhile, the secondary market refers to venues where investors purchase securities from other investors rather than from issuing companies themselves. The most important characteristic of the secondary market is the liquidity it offers to the participants. Bonds, which are debt securities where the issuer owes the holders a debt and pays them interest, can be traded in this market.
When a new bond is issued in the primary market, its value in the secondary market may be affected by the prevailing market interest rates. If a bond is issued when the market interest rates are at 5%, it will create a specific interest payment based on its coupon rate. However, if subsequently the market interest rates fall to 3.5%, this bond becomes more attractive, and its value in the secondary market may increase because it offers a higher return than new bonds being issued. Conversely, if the interest rates rise to 6.5%, the bond's value might decrease, as newer bonds offer higher returns.
The value of a bond in the secondary market is also influenced by its present value, which is calculated by considering the bond’s face value, coupon rate, maturity date, and prevailing market interest rates. The bond's present value is the maximum price a buyer would be willing to pay at any given time.