Primary Equity Market

14/05/2020 4 By indiafreenotes

The primary market is the financial market where new securities are issued and become available for trading by individuals and institutions. The trading activities of the capital markets are separated into the primary market and secondary market.

In a primary market, securities are created for the first time for investors to purchase. New securities are issued in this market through a stock exchange, enabling the government as well as companies to raise capital.

For a transaction taking place in this market, there are three entities involved. It would include a company, investors, and an underwriter. A company issues security in a primary market as an initial public offering (IPO), and the sale price of such new issue is determined by a concerned underwriter, which may or may not be a financial institution. An underwriter also facilitates and monitors the new issue offering. Investors purchase the newly issued securities in the primary market. Such a market is regulated by the Securities and Exchange Board of India (SEBI).

The entity which issues securities may be looking to expand its operations, fund other business targets or increase its physical presence among others. Primary market example of securities issued includes notes, bills, government bonds or corporate bonds as well as stocks of companies.

The primary market is where companies issue a new security, not previously traded on any exchange. A company offers securities to the general public to raise funds to finance its long-term goals. The primary market may also be called the New Issue Market (NIM). In the primary market, securities are directly issued by companies to investors. Securities are issued either by an Initial Public Offer (IPO) or a Further Public Offer (FPO).

An IPO is the process through which a company offers equity to investors and becomes a publicly-traded company. Through an IPO, the company is able to raise funds and investors are able to invest in a company for the first time. Similarly, an FPO is a process by which already listed companies offer fresh equity in the company. Companies use FPOs to raise additional funds from the general public.

Raising Funds from the Primary Market

Below are some of the ways in which companies raise funds from the primary market:

  1. Public Issue

This is the most common way to issue securities to the general public. Through an IPO, the company is able to raise funds. The securities are listed on a stock exchange for trading purposes.

  1. Rights Issue

When a company wants to raise more capital from existing shareholders, it may offer the shareholders more shares at a price discounted from the prevailing market price. The number of shares offered is on a pro-rata basis. This process is known as a Rights Issue.

  1. Preferential Allotment

When a listed company issues shares to a few individuals at a price that may or may not be related to the market price, it is termed a preferential allotment. The company decides the basis of allotment and it is not dependent on any mechanism such as pro-rata or anything else.

Why companies issue shares to the public?

Companies come to the primary market to raise money for expansion. As each and every company requires capital for expansion and growth.

The capital can be in the form of:

  • Equity: It is termed as the stock capital of the company, also known as share capital.
  • Debt: it is termed as the loans taken by the business

The money raised in the primary market goes directly to issuing company. It is a place where capital formation takes place.

The issue can be in the form of a public issue, private placement, preferential issue, rights, and bonus issue.

A public issue does not limit anyone (individual, organization, or corporate) in investing, while in private placement, the issuance is done to select a number of people.

  • Allotment done to more than 200 people, becomes public allotment
  • Allotment done to less than 200 people, becomes private allotment

Since the securities are directly issued by the companies to its investors, the company receives the money and issues certificate of security to the investor.

The securities issued to the investors in the primary market in:

  • Face value
  • Premium value
  • Par value

When the issue of securities closes, then the securities are traded on the secondary market such as stock exchange, bonds market, derivative exchange.

Primary Market

Secondary Market

It is a way of issuing fresh shares in the market. It is also called New Issue Market. A major component of the primary market is the IPO. It is a place where already issued or existing shares are traded. It is called After Issue Market.
The amount received from the issue of shares goes to the company for their business expansion purposes. The amount invested by the buyer of shares goes to the seller, and hence the company doesn’t receive anything.
Securities are issued by the companies to the investors. Securities are exchanged between buyers and sellers, and stock exchanges facilitates the trade.
The securities are all issued at one price for all investors participating in the offering. Securities are exchanged at the market price.
The primary market doesn’t provide liquidity for the stock. The secondary market provides liquidity to the stock.
Underwriters act as intermediaries. Brokers act as intermediaries.
On the primary market, security can be sold just once. On the secondary market, securities can be sold innumerable times.

Functions of Primary Market

To understand the primary market definition in depth, let’s also discuss the functions of primary market. The general function of primary market is to channelize funds in to industrial enterprises. There are three functions of primary market which are given below:

  1. Origination

The term origination refers to the work of investigation and analysis and processing of new proposals. Specialist agencies perform these functions which act as sponsors of the issue. The preliminary investigation entails careful study of technical, economical, financial, and legal aspects of the issuing companies.

This is to ensure that it warrants the backing of the issue houses in the sense of lending their name to the company. Thus, give the issue the stamp of respectability. It shows company is strong, has good market prospects and is worthy of stock exchange quotation.

In the process of origination the sponsoring institutions render, as a second function, some service of an advisory nature which goes to improve the quality of capital issues. These services include advice on such aspects of capital issues as:

  • Determination of the class of securities that are going to issue and price of the issues in the light of market conditions”
  • The timing and magnitude of issues
  • Methods of flotation, and
  • Technique of selling, and so on market.
  1. Underwriting

In order to get the success of the issue, underwriters came into role. They guarantee the selling of the issue in case it is not subscribe by public. Hence eliminates the risk of uncertainty. Underwriting service is significant for both company as well as public. Company gets money and public get free of over stress.

  1. Distribution

The sale of securities to the ultimate investors is known as distribution. It is a specialist job which is performed by brokers and dealers in securities. They maintain direct and regular contact with the direct investors.

Significance of Primary Market

The key function of the primary market is to facilitate capital growth by enabling individuals to convert savings into investments. It facilitates companies to issue new stocks to raise money directly from households for business expansion or to meet financial obligations. It provides a channel for the government to raise funds from the public to finance public sector projects. Unlike the secondary market, such as the stock market which trades listed shares between buyers and sellers, the primary market exists for the issuance of new securities by corporations and the government directly to investors.

  1. Household Savings

Companies raise funds in the primary market by issuing initial public offerings (IPOs). These stock offerings authorize a share of ownership in the company to the extent of the stock value. Companies can issue IPOs at par (market value) or above par (a premium), depending on past performance and future prospectus. In a booming economy, a greater number of corporations float IPOs since more investors have surplus funds for investment purposes. Thus, the number of IPOs issued is indicative of the health of the economy. Invariably, smaller companies seeking funds for business expansion are the ones typically that float IPOs. But large, well-established firms also become publicly traded companies to gain visibility and to expand. Companies can raise an additional round of funding in the primary market by floating a secondary public offering.

  1. Global Investments

The primary market enables business expansion and growth for domestic and foreign companies. International firms issue new stocks–American Depository Receipts (ADRs -to investors in the U.S., which are listed in American stock exchanges. By investing in ADRs, which are dollar-denominated, you can diversify the risk associated with putting all your savings in just one geographical market.

  1. Sale of Government Securities

The government directly issues securities to the public via the primary market to fund public works projects such as the construction of roads, building schools etc. These securities are offered in the form of short-term bills, notes that mature in two to seven years, longer-term bonds and treasury inflation-protected securities (TIPS) linked to the Consumer Price Index. Visit the U.S. Treasury website for information about interest rates and maturity dates.

  1. Primary Market Participants

An investment bank sets the offer price of the corporate security as opposed to market forces, which determines the price in the secondary market. While brokerage firms and online licensed dealers sell IPOs to the public, you may not be allotted IPO shares because of the large demand for a small number of shares typically issued by the company. Moreover, institutional investors (large mutual funds and banks) usually get the lion’s share of much anticipated IPOs.

  1. Marker Risk

Government-issued U.S. Treasury bonds are free of credit risk. However, the Securities and Exchange Commission cautions investors that IPOs are inherently risky and therefore unsuited for low network individuals who typically are risk-averse.