Nature and Definition of Primary Markets
In the financial world, the term “primary market” refers to a market where newly issued securities are sold to the public for the first time. This type of market is also called the “new issue market” or “initial public offering (IPO) market.” Primary markets are important because they provide companies with the opportunity to raise capital by selling securities directly to investors, and they provide investors with the opportunity to invest in newly issued securities at their original price.
In a primary market, the company or government entity that is issuing the securities will hire an underwriter to help sell the securities. The underwriter acts as an intermediary between the issuer and the public and helps to determine the price of the securities based on market demand.
The primary market is different from the secondary market, where investors can buy and sell securities that have already been issued. In the secondary market, the price of a security is determined by supply and demand, and investors buy and sell securities from each other, rather than from the issuing company.
The primary market is an important component of the financial system because it allows companies to raise capital for their operations, investments, and expansion. It also provides investors with opportunities to participate in the growth of these companies and to earn a return on their investment.
Functions of the Primary Market
|Access to wider markets and investors||The primary market provides companies with the opportunity to reach a larger pool of potential investors beyond their existing shareholders. This can lead to increased capital formation and greater opportunities for growth.|
|Transparent Pricing Mechanism||The primary market ensures that the price of securities is determined through an open and transparent process. This helps to promote investor confidence and can result in fair pricing for both the issuing company and investors.|
|Ownership Diversification||The primary market allows existing shareholders to diversify their holdings by selling a portion of their stake to new investors. This can help to mitigate risk and reduce the concentration of ownership in the hands of a few investors.|
|Better Disclosures||Companies are required to provide detailed information about their operations and financial performance when they issue securities in the primary market. This helps investors make informed decisions and reduces information asymmetry between the issuing company and investors.|
|Evaluation by Investors||The primary market allows investors to evaluate the potential of an issuing company and its securities before investing. This can help investors make informed investment decisions and reduce the likelihood of investing in unsuitable or high-risk securities.|
|Exit for Early Investors||The primary market provides early investors with an exit strategy for their investment. This can be especially important for venture capital firms and angel investors, who may be seeking to exit their investments after a few years.|
|Liquidity for Securities||The primary market provides liquidity for newly issued securities, allowing investors to buy and sell them easily. This can help to promote market efficiency and reduce the risk of holding illiquid securities.|
|Regulatory Supervision||The primary market is subject to regulatory oversight, which helps to ensure that issuers comply with legal and ethical standards. This can help to promote transparency, fairness, and integrity in the market, and protect investors from fraudulent or unethical practices.|
Types of Issues
The types of issues:
|Type of Issue||Description|
|Public issue||A company offers its shares to the general public through an initial public offering (IPO). The shares are sold to investors who apply for them through an application process.|
|Private placement||Private placement of shares made to qualified institutional buyers such as mutual funds, insurance companies, pension funds and foreign institutional investors.|
|Preferential issue||Shares are issued to a select group of investors, such as promoters or existing shareholders, at a price that is usually lower than the market price.|
|Qualified Institutions Placement||Private placement of shares made to qualified institutional buyers such as mutual funds, insurance companies, pension funds, and foreign institutional investors.|
|Rights issue||Existing shareholders are given the right to purchase additional shares in proportion to their existing shareholding, usually at a discounted price.|
|Bonus issue||Shares are issued to existing shareholders in proportion to their existing shareholding, usually as a form of reward or recognition of the company’s profitability. The shares are issued free of cost, with no cash consideration required.|
Types of Issuers
|Type of Issuer||Description|
|Central, State and Local Governments||Governments are significant issuers in the primary market. They issue securities such as bonds, T-bills, and other government securities to finance their expenditure. These securities are usually considered to be low-risk investments since the creditworthiness of the government is assumed to be strong.|
|Public Sector Units (PSUs)||PSUs are government-owned companies that are established to provide essential services to the public. These companies may be engaged in a range of activities, from manufacturing and infrastructure development to telecommunications and power generation. PSUs may issue equity or debt securities in the primary market to finance their operations.|
|Private Sector Companies||Private sector companies may issue securities in the primary market to raise funds for their operations. These companies may be engaged in a range of activities, from manufacturing and services to technology and retail. Private sector issuers may issue equity or debt securities, depending on their requirements.|
|Banks, Financial Institutions, and Non-Banking Finance Companies (NBFCs)||Banks, financial institutions, and NBFCs are significant issuers in the primary market. They issue securities such as bonds, debentures, and other debt securities to raise funds to finance their operations. These issuers may also issue equity securities in the primary market to raise capital.|
|Mutual Funds||Mutual funds are investment vehicles that pool money from investors and invest in a diversified portfolio of securities. Mutual funds may issue units in the primary market to raise funds from investors. These units are redeemable, and investors may buy or sell them on an ongoing basis.|
|Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)||REITs and InvITs are investment vehicles that invest in income-generating real estate and infrastructure assets, respectively. These trusts issue units in the primary market to raise funds from investors. The income generated by the assets is distributed to the unit holders in the form of dividends.|
|Alternative Investment Funds (AIFs)||AIFs are privately pooled investment funds that invest in a range of assets such as private equity, hedge funds, and real estate. These funds may issue units in the primary market to raise funds from investors. AIFs are typically targeted at high net worth individuals and institutional investors.|
Types of Investor
|Type of Investor||Description|
|Resident Individuals||Indian citizens who reside in India and invest in primary market issues.|
|Hindu Undivided Family||Joint family unit governed by Hindu Law, consisting of several members who collectively invest in issues.|
|Minors through Guardians||Minors who have legal guardians who invest on their behalf.|
|Registered Societies/Clubs||Non-profit organizations that are registered under the Societies Registration Act or any other act.|
|Non-Resident Indians (NRI)||Indian citizens who reside outside India and invest in primary market issues.|
|Persons of Indian Origin||Individuals who are not Indian citizens but have ancestors from India.|
|Banks||Financial institutions that accept deposits from the public and lend money to borrowers.|
|Financial Institutions||Institutions that provide financial services to customers, such as banks, insurance companies, etc.|
|Association of Persons||A group of individuals who come together for a particular purpose, such as a partnership.|
|Companies||Business entities that are incorporated under the Companies Act and issue shares to raise capital.|
|Partnership Firms||Businesses that are owned and managed by two or more partners.|
|Trusts||A legal entity created to hold assets for the benefit of a third party.|
|Foreign Portfolio Investors||Non-Indian investors who invest in Indian securities.|
|Limited Liability Partnerships (LLP)||Hybrid partnership that offers limited liability to its owners, similar to a corporation.|
Types of Public Issue of Equity Shares
Types of Public Issue of Equity Shares:
a. Initial Public Offer (IPO):
- Fresh Issue of Shares: This is the type of IPO in which a company issues new shares to the public for the first time to raise capital. The funds raised through the fresh issue of shares are used for the expansion of the business, repayment of debts, and for general corporate purposes. Example: the IPO of Indian Railway Finance Corporation (IRFC) in 2021 where the company issued fresh shares to raise capital.
- Offer for Sale: In this type of IPO, the existing shareholders of a company sell their shares to the public for the first time to raise capital. The company does not receive any funds from the offer for sale. Example: the IPO of Indian Railway Catering and Tourism Corporation (IRCTC) in 2019, where the Government of India offered its stake in the company through an offer for sale.
b. Further Public Offer (FPO): A further public offer (FPO) is a type of public issue where an already listed company issues new shares to the public to raise additional capital. The funds raised through the FPO can be used for expansion, debt repayment, or general corporate purposes. Example: the FPO of Oil and Natural Gas Corporation (ONGC) in 2019 where the company issued new shares to raise capital.
Pricing a Public Issue of Shares
When a company decides to issue shares to the public, it needs to determine the price at which the shares will be sold. This is known as the pricing of the public issue of shares. There are two main methods of pricing a public issue of shares:
- Fixed Price Issue: In a fixed price issue, the company sets a fixed price for the shares, which is announced before the issue opens. Investors who want to subscribe to the issue need to pay a fixed price for the shares. This method of pricing is commonly used for smaller issues or for companies that are less well-known.
- Book-Built Issue: In a book-built issue, the company does not set a fixed price for the shares. Instead, it invites bids from investors for the shares. The bids are then used to determine the final price at which the shares will be sold. This method of pricing is commonly used for larger issues or for companies that are well-known.
The book-building process involves the following steps:
- The company appoints a merchant banker to manage the issue and to act as the book runner.
- The company sets a price range for the shares and announces the issue.
- Investors submit bids within the price range.
- The bids are then analyzed and the final price is determined based on the demand for the shares.
- The shares are then allocated to investors at the final price.
Book building allows the company to gauge the demand for its shares before the issue is finalized. It also allows for a more efficient pricing mechanism as the final price is determined based on market demand.
Regulatory Norms for Public Issue of Shares
Regulatory norms for the public issue of shares include various rules and regulations that companies have to comply with while issuing shares to the public. Some of the key norms are:
- Book building versus Fixed Price Issue: The Securities and Exchange Board of India (SEBI) has mandated that companies can issue shares to the public through two modes- fixed price issue or book building issue. In a fixed price issue, the price of shares is pre-determined and mentioned in the offer document. In a book-building issue, the price of shares is discovered through a process of bidding by investors.
- Period of Subscription: The period during which investors can apply for shares in a public issue is known as the subscription period. SEBI has mandated a minimum subscription period of three working days and a maximum subscription period of ten working days.
- Allotment of issue: The allotment of shares in a public issue has to be done in a fair and transparent manner. SEBI has specified guidelines for the allotment process, which include giving priority to retail investors, allotting shares on a proportionate basis, and ensuring that no investor gets more than the maximum permissible limit.
- Role of Registrar in an Issue: The Registrar to the issue is appointed by the company to handle the issue-related formalities such as processing of application forms, allotment of shares, and refund of excess money. SEBI has prescribed norms for the appointment of Registrars and their role in the public issue.
- Listing of Issue: After the allotment of shares is done, the company has to list its shares on the stock exchange. SEBI has laid down guidelines for the listing process, which includes the time period within which the shares have to be listed and the minimum public shareholding requirements that the company has to comply with.
Applying to a Public Issue
Applying to a public issue of securities involves several steps, as follows:
- Obtain the offer document or prospectus: The offer document or prospectus contains all the necessary details about the public issue, including the company’s financials, business model, pricing, and subscription details. It can be obtained from the company’s website, the SEBI website, or the lead manager’s website.
- Open a bank account with ASBA facility: With effect from January 1, 2016, payment for applications made in a public issue must be made only using the ASBA facility. To apply for a public issue, an investor needs to open a bank account with ASBA facility with their designated bank.
- Fill out the application form: The application form can be obtained from the company’s website, the SEBI website, or the lead manager’s website. It contains details such as the investor’s name, address, bank account details, and the number of shares they want to apply for.
- Submit the application form: The filled-out application form along with the cheque/demand draft for the amount of shares applied for should be submitted to the designated bank.
- Wait for the allotment: Once the issue closes, the cut-off price is determined based on the bids received. All investors who bid at the cut-off price or higher are successful bidders and receive allotment at the cut-off price. Investors who bid lower than the cut-off price will receive the refund of their application amount. The issuer credits the shares to the beneficiary demat account of the successful applicants, and refunds for partial or non-allotment.
The following table explains the process of applying to a public issue in detail:
|1||Obtain the offer document/prospectus|
|2||Open a bank account with ASBA facility|
|3||Fill out the application form|
|4||Submit the application form and payment|
|5||Wait for the allotment|
It is important to note that the subscription period for a public issue is limited and investors need to apply within this period. Investors can bid at the cut-off price or at a specified price. Bidding at the cut-off price ensures that the investor’s application is always accepted. If the issue is oversubscribed, the shares will be allotted on a proportionate basis, and if undersubscribed, all applying investors at or above the cut-off price will receive allotments. The issuer will credit the shares to the beneficiary demat account of the successful applicants, and refunds will be made for partial or non-allotment.
Public Issue of Debt Securities
A public issue of debt securities is similar to a public issue of equity shares, but instead of equity shares, the issuer offers debt securities such as debentures, bonds, and notes to the investors. The issuers of debt securities are typically companies or governments that are looking to raise funds for various purposes such as financing a project or refinancing an existing debt.
The process of a public issue of debt securities is regulated by SEBI and is similar to that of equity shares. The issuer has to file a prospectus with SEBI and obtain its approval before making the issue. The prospectus contains all the relevant information about the issuer, the issue, the terms and conditions, and the risks involved. The investors can access the prospectus on SEBI’s website or the issuer’s website.
The pricing of the issue can be done through a fixed-price mechanism or a book-building mechanism. In a fixed-price mechanism, the issuer fixes a price for the debt securities, and the investors can apply at that price. In a book-building mechanism, the investors can bid for the debt securities, and the final price is determined based on the bids received.
The investors can apply for the debt securities during the subscription period by filling out the application form and submitting it along with the payment through the ASBA facility. The allotment of the debt securities is done on a proportionate basis, and the securities are credited to the investors’ demat accounts. The issuer pays the interest on the debt securities periodically, and the investors can trade the securities on the stock exchange.
A rights offer is a type of public issue of securities in which existing shareholders of a company are given the right to purchase additional shares of the company at a discounted price. This offer is made by the company to its existing shareholders in proportion to their existing holdings of shares.
The purpose of a rights offer is to raise capital for the company and to give existing shareholders an opportunity to increase their ownership in the company. The offer allows shareholders to purchase new shares at a lower price than the current market price, which can be an attractive opportunity for investors.
The process of a rights offer typically involves the following steps:
- The company announces the rights offer and the terms of the offer, including the number of new shares being issued, the subscription price, and the ratio of new shares to existing shares.
- Existing shareholders are notified of the offer and given a specified period of time, known as the subscription period, to exercise their rights to purchase the new shares.
- Shareholders who wish to exercise their rights must complete an application form and submit payment for the new shares by the end of the subscription period.
- If all of the new shares are not subscribed by existing shareholders, the company may offer the remaining shares to other investors through a public offering.
- The new shares are issued to shareholders who exercised their rights, and their ownership percentage in the company increases accordingly.
Rights offers can provide a number of benefits to both the company and its shareholders. For the company, a rights offer can be an efficient way to raise capital without incurring significant underwriting fees or diluting the value of existing shares. For existing shareholders, a rights offer can provide an opportunity to increase their ownership in the company at a discounted price, potentially increasing their returns on investment.
Private Placements in Equity and Debt
Private placement is a method of raising capital in which a company sells securities to a select group of investors, such as institutions and wealthy individuals, rather than offering them for sale to the general public. This method is commonly used by companies that do not wish to go public or do not want to deal with the complexities of a public offering. Private placements can be made in both equity and debt securities. In a private placement of equity, a company sells shares of its stock to a select group of investors in exchange for capital. In a private placement of debt, a company issues bonds or other debt securities to a select group of investors in exchange for capital. Private placements are typically subject to fewer regulatory requirements than public offerings, but they may also be subject to certain restrictions on resale or transferability of the securities.
Qualified Institutions Placement
Qualified Institutions Placement (QIP) is a type of private placement of securities by a listed company to qualified institutional buyers (QIBs) such as mutual funds, banks, insurance companies, and foreign institutional investors. QIPs are governed by SEBI guidelines and are commonly used by listed companies to raise capital quickly without going through the lengthy process of a public issue. The issuer determines the price of the securities and the QIBs are allowed to subscribe to the issue through a book-building process. The minimum size of the QIP issue should be Rs. 50 crores and the maximum size should not exceed five times the net worth of the issuer. QIPs are usually dilutive in nature and can result in a change in ownership of the company.
Role and Function of the Secondary Market
The secondary market refers to the platform where already issued securities are traded among investors, and the primary objective is to provide liquidity to investors who want to buy or sell securities. The secondary market provides investors with an opportunity to invest in securities, and it helps in price discovery, which is essential for valuing security.
a. Liquidity: Secondary markets provide a platform for investors to buy and sell securities, enabling them to convert their investments into cash whenever they need to. This liquidity also attracts more investors, leading to more trading and better price discovery.
b. Price Discovery: Secondary markets help in determining the fair price of a security based on the demand and supply of the security. The price of a security in the secondary market is based on its perceived value by the market participants.
c. Information Signaling: Secondary markets provide information to market participants about the performance of the underlying company, such as its financial performance, management quality, and growth prospects. This information helps investors make informed decisions and also acts as a signal to the management of the company about the performance of the business.
d. Indicating Economic Activity: The performance of the secondary market can indicate the general economic activity of a country or region. If the market is performing well, it can indicate positive economic growth and vice versa.
e. Market for Corporate Control: The secondary market also provides a platform for corporate restructuring and mergers and acquisitions. The ability to buy and sell large amounts of securities quickly enables companies to buy out other companies or merge with them, leading to consolidation and growth in the market.
Market Infrastructure Institutions (Stock Exchange, Clearing Corporations, and Depositories)
Market Infrastructure Institutions are the backbone of the securities market as they provide the necessary infrastructure and framework for the smooth functioning of the market. The following are the major Market Infrastructure Institutions in the securities market:
- Stock Exchange: A stock exchange is a marketplace where buying and selling of securities take place. It is an organized market where the securities issued by various companies are traded. The stock exchange provides a platform for investors to buy and sell securities. It also ensures transparency in transactions, provides liquidity to securities, and facilitates price discovery.
- Clearing Corporation: A clearing corporation is an organization that acts as an intermediary between the buyer and the seller in a securities transaction. The clearing corporation ensures the settlement of trades and guarantees the performance of trades. It also reduces counterparty risk by acting as a counterparty to both the buyer and seller.
- Depositories: A depository is an organization that holds securities in electronic form. It provides a safe and secure mechanism for the holding and transfer of securities. The depository system has replaced the physical transfer of securities, making it easier and faster to settle trades. There are two depositories in India, the National Securities Depository Limited (NSDL) and the Central Depository Services Limited (CDSL).
- Depository Participant (DP): A DP is an intermediary between the investor and the depository. A DP can be a bank, financial institution, or broker. It provides services like dematerialization, rematerialization, account maintenance, and settlement of trades.
- Custodian: A custodian is an organization that holds securities on behalf of investors. It provides services like the safekeeping of securities, settlement of trades, and income collection. Custodians are mostly used by institutional investors who invest in multiple securities across different markets.
- Members of Stock Exchange: Members of a stock exchange are intermediaries who are authorized to trade on the stock exchange on behalf of their clients. Members of the stock exchange include brokers, sub-brokers, and trading members.
- Investors: Investors are individuals or institutions who buy and sell securities in the securities market. They include retail investors, high-net-worth individuals, mutual funds, and institutional investors.
- Issuers: Issuers are companies that issue securities in the securities market. They include listed companies, unlisted companies, and government entities.
- Regulators of the Securities Market: Regulators of the securities market are government bodies that regulate and oversee the activities of all the participants in the securities market. In India, the Securities and Exchange Board of India (SEBI) is the regulator of the securities market. Its primary role is to protect the interests of investors and ensure the development of the securities market in India.
a. Market Capitalization:
Market capitalization refers to the total value of all listed companies’ shares traded on a stock exchange. In the Indian stock market, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) are the two major exchanges. As of May 2023, the total market capitalization of BSE was around Rs. 244 trillion ($3.3 trillion), and that of NSE was around Rs. 249 trillion ($3.4 trillion).
Some of the largest companies by market capitalization in the Indian stock market are Reliance Industries, Tata Consultancy Services, HDFC Bank, Infosys, Hindustan Unilever, and ICICI Bank.
b. Market Turnover:
Market turnover refers to the total value of all shares traded on a stock exchange within a particular period. In the Indian stock market, the NSE has a higher turnover compared to the BSE. As of May 2023, the average daily turnover of NSE was around Rs. 7.5 trillion ($102 billion), while that of BSE was around Rs. 4 trillion ($54 billion).
c. Market Indices:
Market indices are indicators of the performance of the stock market and are calculated based on the weighted average of selected stocks. In the Indian stock market, the two main indices are the BSE Sensex and NSE Nifty. The BSE Sensex is a benchmark index of the BSE and comprises 30 of the largest and most actively traded stocks. On the other hand, the NSE Nifty is a benchmark index of the NSE and comprises 50 of the most actively traded stocks.
As of May 2023, the BSE Sensex was around 60,000 points, while the NSE Nifty was around 18,000 points. These indices are widely used as barometers of the Indian stock market’s overall health and performance.
Risk Management Systems in the Secondary Markets
|Risk Management Systems in the Secondary Markets||Detailed Description|
|Capital Adequacy Norms||Capital Adequacy Norms are the norms set by the regulator to ensure that intermediaries and market participants have adequate capital to support their market activity. These norms specify the amount of capital an intermediary or a market participant must maintain in relation to their market risk exposure. In India, capital adequacy norms are set by the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI).|
|Margins||Margins are the upfront funds that a trader or an investor must deposit with the broker or the exchange to trade or invest in securities. Margins serve as collateral against the losses that the trader or the investor may incur. Margins can be in the form of cash or securities. In India, the margins are determined by the exchanges and are subject to regulation by the SEBI.|
|Circuit Breakers and Price Bands||Circuit Breakers and Price Bands are the mechanisms used by the exchanges to prevent excessive volatility and market manipulation. Circuit Breakers and Price Bands are designed to temporarily halt or restrict trading when prices move beyond a certain limit. In India, the circuit breakers and price bands are set by the exchanges and are subject to regulation by the SEBI.|
|Settlement Guarantee Mechanism||Settlement Guarantee Mechanism is a mechanism used by clearing corporations to ensure the settlement of trades in case of default by any trading participant. The clearing corporation acts as a counterparty to every trade and ensures the settlement of trades by providing a guarantee to its members. In India, the settlement guarantee mechanism is provided by the Clearing Corporation of India Limited (CCIL).|
|On-line Monitoring||On-line Monitoring is a system used by the exchanges and the regulators to monitor the market activity in real-time. On-line Monitoring systems are designed to detect any irregularities or violations of the market rules and regulations. In India, the On-line Monitoring systems are provided by the exchanges and are subject to regulation by the SEBI.|
|Price Monitoring and Action||Inspection of Books is a mechanism used by regulators to inspect the books and records of the market participants to ensure compliance with the rules and regulations. Inspection of Books is carried out by the regulators to detect any irregularities or violations of the market rules and regulations. In India, the Inspection of Books is conducted by the SEBI and the exchanges.|
|Inspection of Books||Inspection of Books is a mechanism used by the regulators to inspect the books and records of the market participants to ensure compliance with the rules and regulations. Inspection of Books is carried out by the regulators to detect any irregularities or violations of the market rules and regulations. In India, the Inspection of Books is conducted by the SEBI and the exchanges.|
Corporate Actions refer to events initiated by a company that can affect the value of its securities. These actions are taken by a company to reward its shareholders or raise funds for business purposes. Here are some types of Corporate Actions:
a. Right Issues: A right issue is a way to raise capital by offering new shares to existing shareholders at a discounted price. The shareholders can either accept or renounce the offer. If they choose to renounce it, they can sell the rights to other investors.
b. Bonus Issues: A bonus issue is an offer of free additional shares to existing shareholders. This is done by capitalizing the company’s reserves and surplus.
c. Dividend: Dividend is a portion of the company’s profits that is distributed to its shareholders. Dividends can be paid in cash or as additional shares.
d. Stock split: A stock split is a process in which the number of shares outstanding is increased, but the total value of the shares remains the same. For example, a 2-for-1 stock split would double the number of shares outstanding, but each share would be worth half the original value.
e. Share buyback: Share buyback is when a company buys back its own shares from the open market. This can be done to boost the share price or to prevent a hostile takeover.
f. Delisting of shares: Delisting of shares is when a company voluntarily removes its shares from the stock exchange. This can be done if the company is no longer able to meet the listing requirements or if it has been acquired by another company.
g. Mergers and acquisitions: Mergers and acquisitions (M&A) refer to the process of combining two or more companies into one. This can be done through a variety of methods, such as stock swaps or cash payments.
h. Offer for sale: Offer for sale is when the promoters of a company sell their shares to the public through the stock exchange. This is done to comply with regulatory requirements or to reduce their stake in the company.