Primary Market | Definition | Example | Functions
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Primary Market | Definition | Example | Functions

hello everyone hi and welcome to the
channel of WallStreetmojo friends today we are going to discuss fantastic
topic that is called primary market well once we when we talk about primary
market what is the first thing that comes into a picture is when a company
wants to issue their shares in the market that is in the public then that’s
known as public issue so this is the first time when the company is coming
out in public and asking for money from the shareholders to run the business
this is in a very crude language if we are talking about so as you can see the
primary market is the primary market is divided into couple of parts the one is
public issue which is which happens at the very first time when the company is
coming out for with its first issue then after the private placement after this
there has to be following public offer there is FTO that is known as follow-on
public offer then the private placement comes which is known as qualified
institutional placements and post that this is preferential allotment which is
known as preferential allotment and a rights issue which is sort of an grant
which is given to the existing shareholders if they don’t want to take
those shares then they can renounce those shares to the outside shareholders
so in this fashion the primary market is divided so what are primary market see
most of the large-scale growth and development activities of entities such
as companies as well as government need to be financed by raising external
capital see majority of the companies you can say expansion work growth level
if they want to do and if they don’t want to get into the deep hole of debts
then they can go out in public and they can ask money from there so this is
basically external capital that comes in various and simple as well as the
complicated forms and the whole process is basically been performed by an
investment banker who acts as an underwriter in this particular scenario
apart from taking loan from financial institutions and entity needs to issue
some kind of financial instrument or security like stocks
of bonds so such thing helps a lot because at the end of the day stocks
bonds and in case of in case of bonds and in case of loan you are liable and
there is a front-end liability but in case of the stockholders the
shareholders they are the last one to receive at the time of the liquidation
so it is easy for the company to issue such shut shares but at the end of the
day primary market you can say that it is little bit expensive because over
there there is a lot of expenses that I involved legal expenses investment
bankers expenses regulatory expenses so it involves a much higher level of money
over there so as you can see over here if we talk about the definition in all
the primary market you know is that part of the capital market where new
securities are created and directly purchased by the investor this is very
important directly purchased by the investor from the issuer and creation of
new security facilities growth with the economy at the same time because there’s
a movement of capital in the market so once the security approaches by the
investors they can be traded in this secondary market so basically the first
time purchaser are the initial shareholders when they feel like that
they want to liquidate their positions so they will sell their shares in the
secondary market where other shareholders will play among themselves
and they will trade the shares with buy and sell activity which goes on and that
goes NYSE OR NASDAQ maybe nifty or Sensex in India so raising capital in
primary market can happen in one of the four ways first is public issue second
one is right issue then the private placement and the preferential allotment
there is a follow-on public also offer also at the same time as a term refer to
companies issuing new securities through initial public offer is like going
public they’re going to the public for the very first time a large number of
investors can purchase this newly issued security in the open market and
investment bankers they play a very major role in this situation because
they help to raise the funds they help to raise the money for the company by
acting as an underwriter the rights issue is an invitation basically to an
existing shareholders to purchase additional news
in proportion to their holding within a fixed time now if this kind of share if
this shoulders are not interested in purchasing the shares then
the company gives them a right to sell this shares that is renouncing of the
shares to the outside shareholders the third is the private placements private
placement refers to raising equity capital from the selected investors like
venture capital funds insurance companies and a Chennai’s that is high
net worth investors those are the people who take part in this particular process
preferential allotment it is the process by which a lot min of shares is done on
preferential basis to select a group of investors so they have a preferential
right over the equity shareholders so over here they act as an equity holder
over here they they get a equity shares same over here equity shares but over
here they get the preferences shares means they have a preferential right over the
equity shareholders now as we have noted about that you know such markets where
company can issue new security is to raise external capital and investors get
their first chance investor gets the first chance to get or to subscribe to
security and that’s why it’s called the primary market the primary market is
also known as the new issue market because once again they are going on for
the very first and the company’s going out for the very first time in the
public for the share issue on 6 to 8 2014 Chinese e-commerce heavyweight
Alibaba filed a registration document to to go public in US and it is the mother
of all initial public offer why it has been same see alibaba’s IPO was the
biggest IPO in the history in this in the whole world because it was close
enough to 4 to 5 billion dollars 24 billion dollars so reading
through alibaba’s S1 interesting education makes me realize that how big
their businesses and how complex is Chinese internet web there is a full
excel or based on financial model that you can download from Alibaba’s
financial model which is available to you all see this alibaba’s IPO today it
is a successful company Paytm Jack Ma who is the CEO and the chairman of this
company he holds stake in Paytm which is once
again a FinTech a company in the similar fashion on 24th March 2014 an online storage company called box filed an IPO and
unreal its plan to raise $250 million dollars so the company is in race to
build basically largest cloud storage platform and it completes with a large
company like Google and rival Dropbox so it was in a tough competition with those
sort of people see what are the function of the primary market see a beginning as
a bigger would wonder how the IPS carried out and you know initial price
of a new security being issued is determined so the answer of the
underwriting groups which facilitates the process for the issuer entity the
underwriter is an important entity in the primary market because they carry
out the functions like this ones as you can see underwriting origination
and distribution so at the very first place they underwrite either it is full
fund a full underwriting that is no forms underwriting or it is partial
underwriting it can be anything it is just an
agreement between the company and the investor banker then there is the
distribution then there is an origination and the distribution process
so as you as you can see the underwriting group consists of the
investment banks and those investment banks are the major bulge brackets they
act as an agent over there sort of a broker you can say and they act for a
price determination for a given security and then oversee its distribution
directly to the investors so basically the price discovery the price
determination is done on the basis of the two formulas with the two way either
it is a random price determination based on the demand of the iodized investors
or the top-notch investors or second is by PE the forward PE multiple X with
the help of that the amount has been determined so how is the underwriting
process go about as mention about a company itself does not actually go in
the primary market to sell security rather it requires one or more
investment banks like JP Morgan Morgan Stanley credits worse Goldman Sachs as
you can as you can see this are all mentioned Goldman Sachs creditors Boston
that is a Barclays Capital JP Morgan and all so in most of the cases it is a
group of investment banks if it is a large issue like you can say if it is a
large issue like Jack Mars company of Alibaba then in that scenario
syndication of bank of works to to come into picture for the issuance of such
IPOs because those are some of the really big IPOs and they really need to
commit themselves over there to make the deal happen and make sure that the
subscription is completely full so how the deal arrangement and the commitment
takes place cforce D over here they sure entity and the underwriting
group they meet and they enter into a deal which includes matching matter like
you know amount of money the company will raise the type of the security they
are going to issue there’ll be an agreement between them so
whatever may be the type of the deal agreed upon them once the agreement has
been done with them a portion of the issued security from the entity is to
sell to the public and over here a once again the syndicate group works and they
may commit to guaranteed amount so that is called the forms underwriting or
forms commitment and by effectively selling the issued securities with the
investors so in another type of commitment the syndicate may not
guarantee the amount that will be raised so that’s what I told you the partial
underwriting so it’s it is dependent upon company to company invest into
investment bank to invest bank whether how they want to go about regarding the
issue now the regulatory issue whenever the regulatory you should come in u.s.
it is SEC in India it is Sebby if it is banking company then RBI comes into
picture Reserve Bank of India so let’s read the process of underwriting is is
in the primary market is time-consuming as I it is expensive as I told you in
the very beginning and also exposes issuer and digital regulatory issues
absolutely they have to pass through humongous level of regulatory works and
they have to get it done internalize that is not done they should hasn’t get
cleared so it is very important component of IPO exposing the company’s
account books of accounts to public scrutiny as well as as to oversight the
sec and in our scenario it is in india if it if we go to sea it is
Seve so before anything else the underwriters and the issuer entity set
the company in general together take the regulatory hurdles and the inversion
bankers are once again they play a major role over here for taking the
responsibility regarding how the things are gone work
out so let’s see what exactly are the cost involved see the first cost that is
involved is the underwriting fee okay underwriting fees is you know it is a
major cost because it did it is the percentage of the direct issue because
the cost involved in the IPO and primary market includes majority of the fees
charged by those syndicate banks legal accounting distributions mailing cost
so basically such cost are really heavy and that stays in close enough to in
between to 3 to 7% so that is that is the amount of the issue 3 to 7%
of the issue well after this you can say Twitter basically I wanted to give you
an example of Twitter have you heard about it Twitter everyone knows it
everyone is there Twitter went on public in 2013 and Goldman Sachs was the lead
underwriter while the syndicate group also included other underwriters like
Morgan Stanley was there and you JP Morgan was there so they charged close
enough to about $59.2 million dollars and as for the fee of
underwriting and for managing the sale so that was around close enough to 3.25%
and of the total $1.82 billion dollars
which was been raised by the company now another concept I want you all to learn
is what is Roadshow this is very important see it is basically an event
that needs to be organized by the issuer to the market to market the securities
to the potential buyers so it is often called as dog and pony show why I let
you know see the roadshow is intended to generate excitement that instinct
which is very important among all the shareholders that a DHN that
excitement level is important and interest in the issues or IPO so it’s
often critical to the success of the offering see in the event the company’s
management including like CEOs and CFOs investors relation individual travel
across the country to generate excitement and interest among the
analysts so that there is a complete level of marketing in that particular
end and the analyst the fund managers the
potential investors like institutional investors the FII is also they also
participate so the event itself can cost millions of dollars I’m not getting it
it really cost millions of dollars hence entering the primary market is not
is no doubt lucrative for the aspirations of the company’s management
but it is very significant stage in company’s life – and it it it is an
equally resource consuming process at the same time now how is the price
determination has been done as I told you the price determination is done with
the help of two method C either the company goes out and the investment
bankers basically they do the building process they take out all the a
Chennai’s investor they ask what are the demand or what is the price exactly they
are ready to pay and based on that offering prices they do some valuation
work and based on that valuation the final price has been departed has been
determined so the first method is offering price method and the second one
is the forward PE multiple method forward price earning multiple method
which is usually you so usually they go for offering price and apart from the
100% of the issue the invest investment bankers also get 15% or extra
as a greenshoe option for stabilizing the share price so greenshoe option is
again provided by the regulatories for same so now deciding on number of shares
to be should see firstly it is very important to recall that you know before
going public a company is already owned by small number of people and it
includes like founding there are likely promoter members the promoters which are
known as the founding members the you can say the venture capital and with the
venture capitalist and the angel investor and the company often issues a
small percentage of the ownership ownership to its senior employees as
compensation so basically it so that you know so such that you know early
employees also owned some part of the company before an IPO so for the sake of
M simply city of the understanding let’s assume
that this owners of the company holds certain different number of shares
within them sort of like different quantity of the shares equal to the
total number of the shares that the company is made of now as the company
needs to raise money and decides to go public this owner needs to part with
some of their ownership to the networkers so for this the original
shareholders of the company needs to decide how much of their stake very
important how much of the stake do they want to give away to fuel the company’s
growth by the investors money that is going to come as a proceeds as of the
IPO now there are a couple of more points that we have to discuss is the
advertising and and understanding the willingness of the institutional
investors now let’s see that now the next thing that we need to understand is
advertisement of the public offering to the institutional investor so as I told
you this Roadshow that happens why the Roadshow happens see it is basically not
to create that interest for these small shareholders but it is all about those
kind of shareholders who are really big the institutional shareholders that we
are talking about and basically as you can see those are they include like top
pension funds the mutual funds the hedge funds the high net worth individuals I
told you a Chennai’s so there are the long-standing clients because the small
investor retail investor won’t be able to absorb the price fluctuation that
could take place after the IPO and as it resident the most retail investor based
their decision on unsophisticated methods that could lead them to their
life saving by purchasing the stock in the unstable environment so once this is
done we can determine now the understanding of the willingness of the
institution institutional investors see after the roadshow if once the roadshow
the institutional investor evaluate the securities that has been issued and
decide upon how many shares they wish to buy so they communicate their wheeling
to the issuer remember I told you the offering price this is how it has been
determined and in fact they submit the request and not orders or bills
regarding how many shares they want to purchase and this request are often
basically conditional they are not on a simple terms they are on the conditional
basis and they specify what kind of price they are
to pay in rare cases they may not specify any any sort of a price range
which is very important so this request our process basically to get a very
rough estimate of the demand of the issue price of the issued security and
this task itself is a quite tricky since in the total demanded number of shares
is usually much more than the number of shares that is to be sure that because
there is a fear of rejection of the request and most institution investor
tend to request a much higher number of shares than they actually want so let’s
see what exactly is secondary market see once these shares that have been issued
in the primary market then all those shareholders were there in the primary
market evil will now if they feel like that they don’t want to hold the
position they will sell off to the secondary market they will sell off they
will sell off the shares in the secondary market and the in the secondary
market the shareholders will trade in on the stock exchange like NYSC and Nasdaq
see the price is again determined at the stock exchange
by Barclays Bank for example like they are known at the the unknown a known as
the designated market may come which is known as the DMM and the opening price
is said to such that the number of trades that can be executed is maximized
based on the number of orders submitted until that time see next this share
starts trading on the stock exchange at the opening price basically remember one
thing they starts trading at the opening price and basically the orders are used
for basically price discovery which is one once again a very important thing
and this completes the journey of the shares from primary market to secondary
market because at the stock exchange they are sold and bought by the entities
other than the issuer itself so let’s make the final conclusion now the
conclusion or in our scenario is sea securities are created in the what
primary market and they stay there for a small amount of time so as they
are sold at the stock exchange by the institutional investors who bought them
during the IPO but the primary market is extremely important for the company that
has decided to go public see the price determination
that is different from company to company and it plays a major role but at
the same time it is not different from the general concept of the demand and
supply balance and perceived value of the offering but it is equally resource
consuming as it has it is basically a product launch you can say and it is
worth it basically so after all the amount of money that the company is able
to raise by going public is determined by how the primary market behaves this
is the most important thing which is taught in the course of CF as a
behavioral finance also I hope you have got the best knowledge regarding the
primary market in second in market good luck everyone
thank you

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