The primary market serves as the launch pad for new securities entering the market. In this article, we’ll delve into the nuances of primary markets, understanding their functions, and differences with the secondary market.
What is Primary Market?
In the primary market, new securities are issued for the first time. These securities can be debt or equity and are used by companies, governments, and organisations to raise funds. Investment banks determine the initial price range for these securities and manage their sale to investors in the primary market.
Key Players of Primary Market
In this market, three main players are involved: the company, investors, and underwriters.
- Companies Issuing Securities: Entities raising capital by issuing new stocks, bonds, or financial instruments.
- Investors: Investors in the primary market buy new securities. They include institutions like funds and individual investors.
- Investment Banks and Underwriters: Facilitators assisting companies in the issuance process by providing advisory services, underwriting, and marketing of securities.
How Does Primary Market Work?
In the primary market, organisations issue new securities aiming to expand their business, fund various goals, or grow their presence. Examples of securities issued in the primary market include government bonds, corporate bonds, notes, bills, and stocks of companies.
A strict set of regulations governs all issues on the primary market. In order to offer securities for sale to investors, companies have to file statements with the Securities and Exchange Board of India (SEBI).
Once all the stocks or bonds in the initial offering have been sold, the primary market closes. Then these securities are available in the secondary market for trading/investing.
Types of Primary Markets
- Public Issue
A public issue refers to the process of offering new securities, such as shares or bonds, to the general public for subscription and purchase.
Companies utilise public issues, like Initial Public Offerings (IPOs), to raise capital and list on stock exchanges. These offerings provide individuals with the opportunity to become shareholders or bondholders, contributing to a company’s growth while potentially reaping financial benefits.
Public issues enable companies to access fresh funds for expansion, research, and operations, enhancing market visibility and investor participation in shaping a company’s future trajectory.
- Private Placement
Private placement involves the sale of securities, like shares or bonds, to a select group of investors, excluding the general public. This method allows companies to raise capital directly from institutional investors or high-net-worth individuals.
Unlike public offerings, private placements have fewer regulatory requirements and offer flexibility in structuring deals. Companies often choose private placement for efficiency and confidentiality. However, it limits market liquidity and may lack the transparency associated with public markets. Private placements are commonly used by companies in the early stages.
- Qualified Institutional Placement
Qualified Institutional Placement (QIP) is a capital-raising tool enabling listed companies to issue shares to Qualified Institutional Buyers (QIB), such as mutual funds, public financial institutions, insurers, foreign venture capital investors, etc. QIPs offer an expedited route to raise funds while maintaining regulatory compliance.
- Preferential Issue
A preferential issue is a capital-raising mechanism where a company offers new shares to a select group of investors, typically existing shareholders or strategic investors. This method enables companies to swiftly raise funds while providing preference to specific stakeholders. Preferential issues often align with expansion plans, debt reduction, or strategic partnerships. While efficient in securing capital, it can lead to dilution of equity.
- Rights Issue
A rights issue is when a company offers its existing shareholders the opportunity to buy additional shares at a discounted price, proportionate to their current holdings. This helps raise capital from within the shareholder base, often for expansion or debt reduction.
- Bonus Issue
A bonus issue involves issuing free additional shares to existing shareholders, based on their current holdings. It enhances shareholder value without affecting ownership proportions. Companies often opt for bonus issues to reward shareholders and increase market liquidity.
Functions of Primary Market
New issue offer
A primary market allows for the offering of new issues that have not previously been traded on other exchanges. Organising a fresh issue market involves, among other things, a thorough evaluation of the project’s feasibility. As a result, a fresh issue market is also called a “new issue market.” Financial arrangements are made specifically for the purpose and take into account promoters’ equity, liquidity ratio, debt-equity ratio, and foreign exchange demand.
Services for underwriting
Underwriting is crucial when launching a new issue. Underwriters are responsible for acquiring unsold shares in a primary market if the company cannot sell the required number of shares. Financial institutions can earn underwriting commissions by acting as underwriters. In order to determine whether taking the risk and reaping the rewards is worth it, investors rely on underwriters. IPOs can be purchased by underwriters who sell them to investors.
New issue distribution
New issues are also distributed in a key marketing arena. These distributions begin with the issuance of a new prospectus. In it, the general public is invited to purchase a new issue, and detailed information about the issue, underwriters, and the firm is provided.
Read More – Dos And Don’ts While Investing In Primary Market
Advantages of Primary Market
- Companies can raise capital at a relatively low cost, and the securities so issued in the primary market have high liquidity because they can be sold in the secondary market almost immediately.
- Primary markets are important for the mobilisation of savings in an economy. Communal savings are mobilised to invest in other channels. Investment options are financed by this.
- Compared to the secondary market, the primary market has considerably fewer chances of price manipulation. Manipulations such as these affect the fair and free operation of the market by deflating or inflating a security’s price.
Disadvantages of Primary Market
- As unlisted companies do not fall under the Securities and Exchange Board of India’s regulatory and disclosure requirements, investors may have limited access to information before investing in an IPO.
- There are varying degrees of risk with each stock, but IPO shares have no historical trading data in a primary market for analysis since the company is offering its shares for the first time through an IPO.
- Small investors may not always benefit from it. Small investors might not receive allocations if a share is oversubscribed.
Examples of Primary Stock Market Selling
Here are a few examples of primary stock market selling:
- Rights issue: In May 2015, Tata Motors, a leading Indian automobile manufacturer, announced a rights issue to its existing shareholders. The company offered Ordinary Shares and ‘A’ Ordinary Shares to eligible shareholders. The funds raised were ₹9,040.56 crores. The funds were intended to be allocated for various purposes, including plant and machinery, research, debt repayment, and general corporate needs.
- Initial Public Offering: In 2008, Reliance Power conducted a high-profile IPO in India. The company issued shares to the public at a price of ₹450 per share for non-retail and ₹430 per share for retail investors. The IPO aimed to raise funds for its ambitious power generation projects across India.
Primary Market vs Secondary Market
|Feature||Primary Market||Secondary Market|
|Definition||New securities are issued and sold for the first time.||Existing securities bought and sold by investors.|
|Purpose||Companies raise capital via new shares or bonds.||Investors trade previously issued securities.|
|Participants||Issuers (companies) and investors (public, institutions).||Investors, traders, stockbrokers, and market makers.|
|Trade Volume||Limited, initial issuance of securities.||Higher trade volume, existing securities change hands.|
|Price Determination||Priced by the company based on valuation and market conditions.||Prices are determined by supply and demand dynamics.|
|Listing on Exchanges||Securities may be listed after issuance.||Traded on stock exchanges where already listed.|
|Role of Intermediaries||Investment banks and institutions underwrite and issue.||Stockbrokers and market makers facilitate trading.|
|Types of Securities||Common stock, preferred stock, bonds, and IPOs.||Common stock, bonds, ETFs, mutual funds, etc.|
|Risk and Return Profile||Higher risk, potentially higher returns for investors.||High to moderate risk.|
|Capital Flow||From investors to the issuing company.||Between investors trading among themselves.|
|Regulation||Regulated by securities regulatory authorities.||Regulated by stock exchanges, and financial authorities.|
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What are the types of primary market issues?
The types of primary market issues include initial public offerings (IPOs), Follow-on Public Offerings (FPOs), Rights issues, Bonus issues, Private placements, Preferential allotments, and Qualified Institutional Placements.
Who can invest in primary market?
Yes, any Indian citizen over the age of 18 can invest in the primary market provided they have opened a Demat and Trading account with a SEBI-registered stock broker. For those under 18, Demat accounts can be opened by submitting documents of the guardian.
Can I invest online in primary market?
Yes, you can invest online in the primary market. For this, all you need to do is open a Demat account and a trading account with a SEBI-registered stock broker who offers an online trading platform.
Is primary market seperate from secondary market?
Yes, a primary market is different from a secondary market. While the primary market only deals with the issue of new securities, including shares, bonds, ETF units, etc., the secondary market, also known as the stock exchange, allows for trading in the existing securities.