What Is Primary Market?
A primary market is where new securities like stocks, corporate bonds, notes, bills, etc. are incorporated for the first time by companies, governments, and other institutions. Such securities thus created are sold to the investors for the first time.
Since the securities are sold on the primary market for the first time, it is also known as New Issue Market (NIM). Companies issuing securities through the primary market use the capital acquired either to reduce their debt or to expand their business goals.
Typically, in a primary market, there are three players.
- A company that’s issuing new securities.
- Investors purchasing those securities.
- A bank or an underwriting firm that oversees facilitates and determines the value of the new security.
A secondary market is a place where shares, bonds, debentures, etc. are exchanged between traders (cum investors). Trades here are facilitated by the stock exchange. In a secondary market, the company that issued shares would not involve in the buying and selling of their securities. All the securities on the secondary market would have first been offered on the primary market.
Differences Between Primary and Secondary Market
|Primary Market||Secondary Market|
|Securities are created for the very first time.||A secondary market is a place where shares are traded among investors/traders.|
|In this market, shares or securities are issued by the companies to the investors.||Here, the exchange of shares is done on an investor-investor basis.|
|Investment bankers do the selling process in a primary market.||Here, the broker acts as an intermediate for the process of trading.|
|Securities in a primary market can be sold only once.||In secondary markets, there can be an infinite number of transactions. Here, buying and selling shares is a never-ending process.|
|Money received from the investors through the securities becomes the capital for a company.||Here, the money acquired through shares becomes income for investors.|
|The other name for the Primary market is the “New Issue Market”||The secondary market is also termed as “After Issue Market”|
|The selling prices are fixed in a primary market.||Demand and supply determine the prices in a secondary market.|
Functions of a Primary Market
Some major functions of a primary market are:
- New Issue Offer
The major function of a primary market is to organize offerings of newly issued shares that have never been traded on any other exchange.
Issuing a new offer involves a detailed assessment of a new project and its viability. It involves analyzing financial things like liquidity ratio, equity ratio, promoter’s debt-equity ratio, etc. related to that company.
2. Underwriting Services:
Another vital aspect of a primary market is underwriting. Underwriters, buy unsold shares. Financial institutions, who mostly play the role of underwriters earn commissions during this process. Investors depend on underwriters to finalize their decision on buying the shares of a company. Sometimes, underwriters even buy an entire IPO issue and sell it to investors.
3. Distribution of the New Issue:
One more important function of a primary market is the distribution of that new issue with a new prospectus. The public is invited at a large scale for the purchase of this new issue, where detailed information is given about the company, underwriters, new issues, etc.
4. Qualified Institutional Placement:
Here, in this type of fund-raising tool, listed companies raise capital by issuing securities to QIBs, who are termed Qualified Institutional Buyers.
It is essential to note that QIBs have the prerequisite expertise and financial knowledge to invest in the capital markets. Qualified Institutional Buyers (QIBs) are generally foreign institutional investors who are registered with SEBI. They can even be scheduled commercial banks, public financial institutions, etc.
Ways Of Raising Funds from Primary Market.
Below are some of the ways of raising funds through primary markets.
IPO, also known as Initial Public Offer, is a way where the public can acquire the shares of a company for the first time. It is one of the fast ways of raising capital. However, SEBI (Securities Exchange Board of India) imposes some regulations to which every company must adhere.
Also sometimes, from some investors’ point of view, IPO is deemed risky. Say, a company performs well, and the investors gain from the solid returns as they would have bought it at a low price. But, on the flip side, some companies struggle to debut profits on the secondary markets due to their poor balance sheets and higher valuations, etc., which could result in a loss.
2. Private Placement
The private placement is a place where companies offer exclusive purchasing rights to hedge funds, investment banks, or institutional investors. Sometimes, they might even reach out to a handful of ultra-net-worth individuals for funding. This is different from an IPO, as it is not open to the public and has fewer regulations compared to an IPO.
Note: Private placement helps startups, and early-stage companies get their funding without reaching the public.
3. Preferential Allotment
This is like a private placement. As per the name, preferential allotment offers shares to a selected group of investors who necessarily might not be shareholders or have any connection with the company.
4. Rights Issue
During rights issues, most companies offer new additional shares to the public at a discounted price. With restricted investor access, most companies extend their benefits of availing their shares to their current shareholders or etc., thus the name ‘rights issue’. This makes investors expand their holdings in that specific company.
Note: One potential downside of the rights issue is that increased share volume leads to dilution in share value.
Advantages of Primary Market
- Primary markets are a cost-effective way for companies to raise and increase their capital at relatively low costs.
- Shares have high liquidity as they can immediately be sold on the secondary market.
- As compared to secondary markets, primary markets have fewer chances of share price manipulation.
- Primary markets offer diversification and are low-risk, high-return financial instruments.
- Primary markets mobilize savings in society.
Limitations of a Primary Market
- Since unlisted companies do not fall under the Securities and Exchange Board of India (SEBI), investors have limited access to information about a company, before investing in it (through an IPO or etc.)
- Huge difficult to get share allocation if the shares of any company get oversubscribed.
Primary markets have the potential to yield big returns to investors. This is the main reason why there is a lot of excitement around an IPO. A Good Online Stock Market Course in India teaches the A-Zs of the stock market.