What Is The Primary Market?
In the primary market, new securities are offered directly to investors. This is the first time they are offered. These securities may be debt or equity. Governments, organizations, or companies use them to raise funds. In financial terms, it is a “new issue market.” Investment banks set the price range for these securities. They also help sell them to investors.
Functions of Primary Market
Let us have a brief understanding of the functions of the primary market. It is simply a three-step process. They are,
- New Issue Offer.
- Underwriting Bodies.
- Distribution of New Issues.
1. New Issue Offer:
- The primary market works on issuing the securities of a company that doesn’t trade in any exchanges.
- They work on various parameters to assess the company’s viability. The report competes with business demographics and all qualitative factors.
- Besides, they root out the understanding and analysis of financial parameters like,
- Promoters Equity holding split up
- Balance Sheet
- Liquidity Ratio
- Profit and Loss Statement
- Debt-to-Equity Ratio
- The requirement of Foreign Exchange.
Once we complete these processes, we will seek investment from underwriting bodies.
2. Underwriting Bodies:
Generally, they are Investment Banks or Financial Institutions. These investment banks play a huge role in the primary market. They provide the initial amount to the company and buy all the equities or bonds. For this, they earn some commission on their service.
Later, they sell those securities to investors who apply for an IPO in the primary market. Underwriting Bodies are the primary indicators for investors applying for an IPO. It can be a group of underwriters, or an individual underwriter can buy all the shares.
Recently, investors fully subscribed to the Burger King IPO within 2 hours of its opening. The Underwriting Bodies of this IPO were,
- Kotak Mahindra Capital Company Limited.
- CLSA India Private Limited.
- Edelweiss Financial Services Limited.
- JM Financial Limited.
3. Distribution of New Issues:
In the primary market, entities can distribute new issues. New prospectus issues make these distributions. A large portion of the public can buy and provide these issues.
Primary Market Instruments:
Post issuance, the investors can avail of securities in 5 ways. Generally known as the types of primary market issues. They are,
- Public Issue
- Private Placement
- Preferential Issue
- Qualified Institutional Placement
- Rights and Bonus.
Public Issue
The public issue is routed by an IPO (Initial Public Offering), which is considered the most common method of primary market issues. It targets the larger public group to raise funds for a company from the capital market.
Private companies can provide this type of issue and become publicly managed companies. The main motto of a private company to apply for public Issues is to,
- Expand their business
- Invest in Infrastructure
- Reduce their debt
Also, trading in the stock market lets you sell more securities later to raise funds.
Private Placement
When a company decides to raise funds from a small group of investors, this is known as a private placement. The securities can be either stocks or bonds.
A private placement offering is easier than a public issue. The investors in these issues can be financial institutions or individuals.
Preferred Issue
This is the quickest method for companies to raise funds. This model allows listed and unlisted companies to issue their securities to select groups.
Qualified Institutional Placement
Qualified Institutional placement is purchased by QIB (Qualified Institutional Buyers). They are entitled to complete or partial securities of an issuing company. During public issues, these QIBs can get a slot by submitting the pre-file issue to SEBI. QIBs get a slot by submitting the pre-file issue to SEBI.
QIBs are generally known as anchor Investors. They can be,
- Foreign Institutional Investor (FII)
- Mutual Funds
- Foreign Venture Capital Groups
- Financial Institution (Private/Public)
- Insurance company
- Scheduled Commercial banks
- Pension Funds by Government.
Rights and Bonus Issues:
The final type of primary market issue is Rights and Bonuses. This method encourages existing investors to purchase more shares.
In a rights issue, existing investors will have the option to buy more shares at a discount. They can do this at a specific time.
Bonus is a kind of endowment to the existing shareholders.
Primary Market Example
Here is an example of a company’s primary market Issues.
- Recently, we might have come across the Rights Issue of Reliance (RIL) in May 2020.
- It was a mega rights issue for Rs. 53124 Cr. The problem was 42.26 Crore Shares at a face value of Rs. 10.
- Almost 14 Merchant Bankers were rolled out as the underwriter bodies.
- After the Rights Issue, RIL’s share price peaked at Rs. 2314, up from Rs. 1008 in just four months.
Advantages of Primary Market:
- Any private company can become a public company. They just need to issue securities in the Primary market.
- This is the only platform for a company to raise funds without interest.
- The primary market provides liquidity for securities through IPOs.
- There are no brokerage fees, Stamp duty, and transaction charges
- Zero volatility in the primary market.
- Securities bought on fresh issues can be sold in the secondary market, so there is a low investment risk.
Disadvantages of the Primary Market:
- It is very hard for retail investors to get into an oversubscribed IPO.
- There is no historical data on the share price.
- The financial and fundamental valuation parameters are limited to 3-4 years.
- Not all the issues by the primary market get listing gain. Many securities are still lower than the IPO price.
Conclusion:
- Primary markets are when investors can purchase securities directly from the issuer.
- In the primary market, companies sell new stocks and bonds to the public for the first time. This happens with an initial public offering (IPO). The price is often set beforehand or negotiated.
- Stock exchanges represent secondary markets, where investors buy and sell from one another.
- A process involves the issue of funds in return for securities. They are New Issue Offers, Underwriting Instructions, and Distribution of new issues.
- There are 5 different types of primary market issues.
- This market generally has more advantages and fewer disadvantages. The risk involved here is very low, as it involves zero volatility.