What are Primary Markets?- Meaning and Functions

When you first begin investing in stocks, one of the concepts you may come across is "primary market." So, what exactly is a primary market? Let's figure it out.

 

Primary Markets

 

Securities are established for the first time in a primary market for investors to acquire them. New securities are issued in this market via a stock exchange allowing both the government and businesses to raise funds. 

 

There are three parties involved in a transaction in this market. 

 

It consists of a corporation, investors, and an underwriter. In an initial public offering (IPO), a corporation issues securities in a primary market, and the price of such a new issue is determined by a concerned underwriter, who may or may not be a financial institution.

 

The organisation issuing securities may want to grow its operations, fund other corporate goals, or extend its physical presence, among other things.

 

Notes, bills, RBI bonds , or corporate bonds, as well as company stocks, are examples of primary market securities issued.

 

Checkout this video in order to understand more about Primary Markets. 

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Basic Market Functions

 

The purposes of such a market are several:- 

 

1. New issue offer: The primary market facilitates the offer of a new issue that has not previously traded on any other exchange. This, as a result, is also known as a "New Issue Market." 

 

Organizing a fresh issue offer entails a thorough evaluation of project feasibility, among other things. 

 

The financial arrangements are made for the purpose and include considerations of promoters' equity,  liquidity ratio, debt-equity ratio, and foreign exchange demand. 

 

2. Services for underwriting: When launching a new issue, underwriting is critical. In a primary market, an underwriter's responsibilities include acquiring unsold shares if it is unable to sell the requisite number of shares to the public. 

 

Underwriting commissions can be earned by a financial institution acting as an underwriter. 

 

Investors depend on underwriters to determine if incurring the risk is worth the potential rewards. It is possible that an underwriter will purchase the whole IPO issue and then sell it to investors.

 

3. New issue distribution: In a key marketing arena, a new issue is also distributed. A new prospectus issuance kicks off this type of distribution. It invites the general public to purchase a new issue and gives thorough information about the firm, issue, and underwriters involved.

 

 

Primary Market Financing Types

 

Following the issuing of securities, investors can acquire them in a variety of ways. There are five different sorts of primary market concerns.

 

1. Public issue

 

The most typical form of issuing a company's securities to the general public is through a public offering. It is generally done through an Initial Public Offering (IPO), which results in corporations raising cash from the capital market. 

 

These securities are available for trading on stock exchanges.When a privately owned firm's shares are first sold to the public through an IPO, it becomes a publicly traded corporation. 

 

A public offering helps a corporation generate capital for corporate development, infrastructure improvements, and debt repayment, among other things. Trading in an open market also boosts a company's liquidity and allows for the issue of more shares to raise additional funds for the firm.

 

SEBI (The Securities and Exchange Board of India) is a regulatory organisation that is responsible for IPO oversight. According to its requirements, a due diligence investigation is conducted into a firm's validity, and the corporation is obligated to include all relevant information in the prospectus for a public offering.

 

 

2. Private Deployment 

 

Private deployment refers to when a corporation distributes its securities to a select group of investors. Bonds, stocks, and other assets may be used, and investors may be both individual and institutional.

 

Because the regulatory requirements for private deployments are substantially less stringent than those for initial public offerings, they are far easier to issue.

 

It also saves money and time, and the firm may remain private. This type of issue is appropriate for start-ups or firms in their early stages. 

 

To obtain cash, the corporation may sell this issue to an investment bank or a hedge fund, or it may sell it to ultra-high net-worth individuals (HNIs).

 

 

3. The Preferential Issue

 

A preferential issue is one of the easiest ways for a company to raise funds. Companies, both public and private, can issue shares or convertible securities to a select group of investors.

 

The preferred problem, on the other hand, is neither a public nor a rights concern. Preference share holders are entitled to receive the dividend before regular shareholders.

 

 

4. Institutional Placement with Accreditation

 

Another type of private deployment is accredited institutional placement, in which a publicly traded company issues securities in the form of equity shares or partially or entirely convertible debentures, in addition to warrants convertible to equity shares and purchased by a qualified institutional buyer (QIB).

 

 QIBs are largely the types of investors who have the necessary financial knowledge and skills to participate in the capital market. Some of the QIBs are:- 

 

• Foreign institutional investors (FIIs) are those who have registered with the Securities and Exchange Board of India.

• Investors in foreign venture capital.

• Alternative Investment Funds (AIFs).

• Mutual funds

• Public Financial Institutions

• Insurers

• Commercial banks that are scheduled.

• Pension Funds

 

Qualified institutional deployment is easier to issue than preferred allotment since it does not include typical procedural requirements such as completing pre-issue filings to SEBI. 

 

As a result, the procedure becomes a lot simpler and less time-consuming.

 

5. Bonus and Rights issues

 

Another type of primary market issuance is the rights and bonus issue, in which the company issues securities to existing investors by offering them the option to purchase additional securities at a predetermined price (in the case of a rights issue) or to receive an allotment of additional free shares (in the case of a bonus issue).

 

In the case of rights issues, investors have the option of purchasing stocks at a reduced price within a set time frame. 

 

The issuance of rights shares increases the control of the company's current owners, and there are no charges associated with the issuance of these types of shares.

 

A firm may offer bonus shares as a present to its current shareholders. However, the issuing of bonus shares does not result in the infusion of new capital.

 

 

Primary Stock Market Selling Examples

Company	Details
Facebook	The Facebook initial public offering was one of the notable IPOs that took place. The IPO, which began in 2012, is still the largest in the technology industry. Through its first public offering, the corporation successfully raised $16 billion. As a result, its turnover increased by approximately 100 percent. Furthermore, there was a large demand for the shares in the primary market, which caused the underwriters to set the price of Facebook's stock at $38 per share. The shares were eventually valued at $104 billion, the largest for a newly founded public firm.
Coal India	Coal India held the largest IPO in India in 2010, raising Rs. 15,200 crore. The shares were initially launched for Rs. 287.75 and later raised to Rs. 340. Retail investors, as well as the company's subsidiaries and workers, received a 5% discount on the final IPO price.

 

In addition to the Union Budget 2020–21, it is suggested that selling a portion of the government's share in the Life Insurance Corporation. Even a 10% share sale may net the government Rs. 80,000 crore. 

 

The insurer's listing (released by IRDA) is the largest initial public offering in India, surpassing the Coal India IPO.

 

(Related Reading:- Top 15 US IPOs of All Time)

 

 

The Advantages of Primary Market

 

 

• Companies may receive funding at a minimal cost, and securities issued in the primary market have great liquidity since they can be traded in the secondary market practically immediately.

 

• The primary market is a significant cause of savings mobilisation in an economy. Commoners' funds are mobilised for investment funds  through various channels. It results in monetary resources being invested in various investment possibilities. 

 

• As opposed to the secondary market, the chances of price manipulation in the primary market are far lower. Manipulation generally takes the form of deflation or inflation of a security's price, interfering with the market's fair and free operation.

 

• The primary market can be used as a source of diversification to reduce risk. It enables an investor to diversify his or her investments across several financial instruments and businesses. 

 

• It is not affected by market movements. Stock prices are decided prior to an initial public offering, and investors know how much money they will need to invest.

 

 

Drawbacks of the Primary Market 

 

• Since unlisted firms are not subject to the Securities and Exchange Board of India regulatory and disclosure obligations, investors may have limited access to information prior to investing in an IPO.

 

• Even though the firm is releasing its shares to the public for the first time through an initial public offering, there is no previous trading data on a major market for analysing IPO shares.

 

• Small investors may find it unfavourable in various situations. Small investors may not obtain a share allocation if a share is oversubscribed.

 

 

Final Thoughts

 

Individuals may make well-informed decisions about investing in the main market with this knowledge about the market. This also helps in paving the way for the development of a risk-diversified investment portfolio.