It is a part of the capital market, also known as the new issue market. This is where a Company or Government sells securities or bonds for funds. In a primary market, the issuer sells the securities directly to an investor.
These securities or shares the investors buy are never traded (Fresh Equities). When a company needs a fund to expand its business, they can go for taking a business loan or becoming a public company.
The process of becoming a public company is by selling securities for the first time in the primary market to raise capital. This process is known as Initial Public Offering.
It is essential to have three bodies for these transactions.
- Company or Issuer
- Investor
- Underwriter.
A company raises funds through an IPO by selling part or full of its securities. Underwriter Bodies calculate the cost for the total securities they sold out. These Underwriters are not mandated to belong to a financial institution (Investment Bank).
The primary market is eligible for providing both private and public issues.
- Public Issues – When the issue is provided to more than 200 investors.
- Private Issues – When the issue is provided to 200 investors.
This is where the new stock or bonds are sold to the public for the first time. Apart from Stocks, and bonds, they also issue bills, notes, etc. But, this process happens with few protocols. The Security Exchange Board of India (SEBI) regulates these protocols and the market.
Functions of Primary Market or New Issue 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.
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 these processes are done, they will look for underwriting bodies to invest.
Underwriting Bodies:
Generally, they are Investment Banks or Financial Institutions. These investment banks deal a huge role in the primary market. They are responsible for providing the initial amount to the company and buying the complete equities or bonds. For which 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, Burger King IPO was released, and it was completely subscribed in 2 hours of opening. The Underwriting Bodies of this IPO were,
- Kotak Mahindra Capital Company Limited.
- CLSA India Private Limited.
- Edelweiss Financial Services Limited.
- JM Financial Limited.
Distribution of New Issues:
The distribution function of New issues can happen in the primary market. New prospectus issues make these distributions. Where a large group of the public can buy these issues and provide.
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 IPO (Initial Public Offering). This 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 publically 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
Besides this, trading in the stock market will provide the scope to increase funds by selling out more securities later.
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 an individual.
Preferred Issue:
This is the quickest method to raise funds for companies. This model allows both listed and unlisted companies to issue their securities to selective groups.
Qualified Institutional Placement:
Qualified Institutional placement is purchased by QIB (Qualified Institutional Buyers). They are entitled to by complete or partial securities of an issuing company. During the public issues, these QIBs can avail of a slot (partition in total issues) 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 is to encourage existing investors to purchase more shares.
In Right Issues, the existing investors will be provided an option to buy more shares at a discounted price at a particular timeframe.
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 issue was for 42.26 Crore Shares at 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 up to Rs. 2314 from Rs. 1008 in just 4 months.
Advantages of Primary Market:
- Any private company can become a public company by issuing its securities in the Primary market.
- This is the only platform for raising funds by a company without interest.
- The primary market provides the liquidy of securities by IPO.
- There are no brokerage fees, Stamp duty, and transaction charges
- Zero volatility in the primary market.
- The securities bought on fresh issues can be sold in the secondary market. So, the a low risk of investment.
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, such as with an initial public offering (IPO) – often at a pre-determined or negotiated price.
- Stock exchanges represent secondary markets, where investors buy and sell from one another.
- There is a process involved in 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.
- Generally, this market has more advantages and fewer disadvantages. The risk involved here is very less as it involves zero volatile.
