What is Primary Market: Types and Key Players

What is Primary Market: Types and Key Players

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Jaya
Jaya Sharma
Assistant Manager - Content
Updated on Jan 15, 2024 13:37 IST

Primary market are crucial for companies to gain capital and for the investors to participate in the growth of these companies.

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Through this article on what is primary market, we will learn about the types of this market and which players are crucial in its existence.

Table of Contents

What is Primary Market?

The primary market, or the “new issue market,” is a financial marketplace where companies issue new securities to the public for the first time to raise capital. Investors who purchase these securities in the primary market buy them directly from the issuing company. This market is an essential component of the capital markets. It provides companies with the funding required to grow and expand their businesses. Investment banks play a crucial role in the primary market as they help companies to determine the offering price and assist with the registration process with regulatory authorities.

Does Primary Market Provide Funding to companies?

Yes, primary market does provide a platform for companies and institutions to raise money. They can issue their securities and IPOs to raise money.

Types of Primary Market

The following are different types of primary markets:

  1. Initial Public Offering (IPO): In an IPO, for the first time, company offers its shares to the public. The company works with underwriters to determine the offering price and structure, and the proceeds raised from the IPO are used for business expansion, debt repayment, or other purposes. Once the shares are issued, they become tradable on the secondary market.
  2. Rights Issue: A rights issue allows existing shareholders of a company to purchase additional shares at a discounted price, proportional to their existing holdings. This method enables companies to raise capital while giving existing shareholders the opportunity to maintain their ownership stake. Rights issues are typically executed through the issuance of rights, which can be traded on the secondary market.
  3. Preferential Allotment: In a preferential allotment, a company issues shares or other securities to a select group of investors at a pre-determined price. This method of issuance is often used to raise capital quickly and at a lower cost compared to public offerings.
  4. Qualified Institutional Placement (QIP): A QIP is a type of private placement in which a publicly traded company issues securities to qualified institutional buyers (QIBs), such as mutual funds, pension funds, or insurance companies. This method is often used by companies to raise capital quickly without going through the extensive regulatory requirements of a public offering.
  5. Private Placement: In a private placement, securities are directly offered to a select group of institutional or accredited investors, bypassing the need for a public offering. This method allows for a faster and less expensive capital raising process compared to public offerings. Private placements can involve the issuance of stocks, bonds, or other types of security in market.
 

Securities Issued in New Issue Market

In this market, various types of securities are issued by companies, governments, and other entities to raise capital from investors. Some common securities issued in this market include:

  • Stocks: “Shares’ or ‘equities’ represent ownership interests in a company. When a company issues stocks in the market, it is typically done through an initial public offering (IPO), where new shares are sold to investors for the first time. The proceeds from the sale of stocks are used by the company to fund business expansion, repay debts, or for other purposes.
  • Bonds: These are types of debt securities issued by companies, governments, or any entities that pay periodic interest to bondholders and return the principal amount upon maturity. In the New Issue market, bonds can be issued through public offerings or private placements. Governments often issue bonds to fund public infrastructure projects or cover budget deficits, while companies issue bonds (corporate bonds) to finance their operations or for investing.
  • Debentures: Debentures are similar to bonds but are unsecured since they are not backed by any collateral. In the primary market, debentures are issued by companies to raise funds for business purposes. The interest rates on debentures are usually higher than those on bonds, reflecting the higher risk associated with unsecured debt.
  • Convertible securities: Convertible securities, such as convertible bonds or convertible preferred stocks, are hybrid securities that can be converted into predetermined number of common shares at a specified time or under specific conditions. Companies issue convertible securities in the primary market to raise capital while offering investors the potential for capital appreciation through conversion into common shares.
  • Preferred stocks: Preferred stocks are a type of equity security that provides investors with a fixed dividend payment and priority over the common shareholders during liquidation. Companies issue preferred stocks in the primary market to raise funds while maintaining a lower level of dilution to existing shareholders compared to issuing common stocks.
  • Commercial papers: Commercial papers are short-term, unsecured debt securities issued by companies to meet short-term funding needs. In the primary market, commercial papers are typically sold at discount and are redeemed at face value upon maturity, with maturities usually ranging from a few days to 270 days.
  • Municipal securities: Municipal securities are the debt securities issued by state or local governments to fund public projects, such as building schools, hospitals, or infrastructure. In the primary market, municipal securities are sold to investors, who in turn receive interest payments that are exempt from federal and, in some cases, state and local taxes.
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Key Market Players

The following are the players in primary market: 

  • Issuers: These are the entities that issue securities to raise capital. They can be private companies going public, government organizations, or existing publicly traded companies issuing additional shares or bonds.
  • Underwriters: Financial institutions, such as investment banks, that act as intermediaries between issuers and investors. Underwriters assist in the process of pricing, marketing, and distributing securities, and they often guarantee a certain amount of proceeds to the issuer.
  • Investors: Entities that purchase the newly issued securities. These can be institutional investors like pension funds, mutual funds, or insurance companies, as well as individual investors.
  • Regulators: Government bodies that are responsible for overseeing and regulating the primary market to ensure transparency, disclosure, and investor protection. In the United States, the Securities and Exchange Commission (SEC) is the primary regulator of securities markets.

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Importance of Primary Market

By investing in the New Issue market, investors gain access to new investment opportunities and earn higher returns. The primary market has a crucial role in financial ecosystem and contributes to economic growth and development in several ways. The following key reasons make primary market important:

  1. Capital formation: The primary market provides a platform for companies, governments, and other entities to raise capital through the issuance of securities such as stocks, bonds, and debentures. This capital can be used to fund business expansion, public infrastructure projects, or repay debts, promoting growth and development across various sectors of the economy.
  2. Investment opportunities: By offering newly issued securities to investors, the primary market provides opportunities for individuals and institutional investors to participate in the growth and success of various organizations. This helps investors diversify their investment portfolios and generate returns through capital appreciation and income from dividends or interest payments.
  3. Resource allocation: The primary market facilitates the transfer of funds from investors to productive sectors of the economy. By channeling capital to companies and projects with growth potential, the primary market contributes to the efficient allocation of resources and supports overall economic growth.
  4. Price discovery: The process of issuing securities in the primary market involves determining the fair market value of securities which is essential for price discovery. The interaction between issuers, underwriters, and investors in the primary market helps establish an appropriate price for the securities, reflecting their perceived value and demand.

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Difference Between Primary and Secondary Market

Aspect Primary Market Secondary Market
Definition Market where new securities are issued to the public for the first time. Existing securities are traded among investors.
Purpose Helps companies raise capital by issuing new shares or bonds. Provides a platform for investors to sell and buy existing securities.
Transaction Parties Transaction occurs between the issuing company and the investor. Transaction occurs between two investors.
Issuance of Securities Involves the creation of new securities. Involves the transfer of existing securities.
Pricing Price of securities is often determined by the issuer (often at a set price). Determined by demand and supply in market.
Frequency Occurs less frequently, only when a company decides to issue new securities. Occurs regularly as investors trade securities daily.
Intermediaries Investment banks often underwrite the securities. Stock exchanges and brokers facilitate transactions.
Examples Initial Public Offerings (IPOs), Rights Issue. Trading of stocks on stock exchanges like NYSE, NASDAQ.
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FAQs

What is a Further Public Offering (FPO)?

A Further Public Offering (FPO) refers to a process via which a company, already listed on an exchange, issues new shares to the investors or the existing shareholders, usually the promoters.

Differentiate primary market and the secondary market.

Securities are created in a primary market whereas they are traded by investors in the secondary market is where those securities are traded by investors. In the primary market, companies sell new stocks and bonds to public for the first time, such as with an IPO. In the secondary market, investors trade previously issued securities without the involvement of the issuing-companies.

Who are the participants in the primary market?

The participants in the primary market include companies issuing the securities, banks that underwrite the issuance (help the issuer to set the price and handle the sale), and investors who buy the securities.

How does a company benefit from the primary market?

Companies can use the primary market to raise capital for purposes such as research and development, infrastructure development, or debt repayment. The primary market allows companies to issue new shares to raise money directly from investors.

What is a greenshoe option?

A greenshoe option is an option that the underwriters of an IPO have to purchase additional shares from the company at the IPO price. Greenshoe options are typically used to stabilize the price of the stock after it starts trading on the secondary market.

What is a bookrunner?

A bookrunner is an investment bank that helps a company issue securities in the primary market. The bookrunner is responsible for marketing the securities to investors and for taking orders for the securities.

What are the benefits of investing in the primary market?

Despite the risks, there are also some potential benefits to investing in the primary market. For example, investors who participate in an IPO may have the opportunity to buy shares at a discount to the price at which they will trade on the secondary market. Additionally, some primary market offerings may offer investors the opportunity to invest in promising companies before they become widely known.

About the Author
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Jaya Sharma
Assistant Manager - Content

Jaya is a writer with an experience of over 5 years in content creation and marketing. Her writing style is versatile since she likes to write as per the requirement of the domain. She has worked on Technology, Fina... Read Full Bio