What is Primary Market?

Primary Market is a Market for new issue of securities, which are issued to public for first time. Primary
market is also known as New Issue Market. It is used by both new and existing companies. The company
issues new shares and debentures for collecting long term funds. The purchaser of new shares and
debentures may be businessmen, customers of the company, employees of the company, existing
shareholders, etc. The issue of securities is made through the prospectus. Functioning of primary
markets facilitates the capital formation by channelizing of funds from individual savers into proper
productive investments.

Functions of Primary Market

1. Origination
2. Underwriting
3. Distribution

1. Origination

In primary market, origination means to investigate, evaluate and procedure new project proposals. It
initiates before an issue is present in the market. It is done with the help of merchant bankers.

The merchant bankers can be ↓

 banks,
 financial institutions,
 private investment firms, etc.

In primary market, the preliminary investigation involves a detailed study of economic, financial, legal,
technical aspects to ensure the soundness of the project. The second function is performed by
sponsoring institutions. They provide advisory service.

Advisory service includes: ↓

 Types of issue,
 Thug,
 Pricing,
 Methods of issue, etc.
2. Underwriting

In primary market, to ensure success of new issue, there is a need for underwriting firms. The company
needs to appoint underwriters. They can be banks or financial institutions or specialized underwriting
firms.

In primary market, underwriting can be done by a single underwriter or by a group of underwriters.

3. Distribution

In primary market, the success of any grand new issue is hinges on the issue is being subscribed by the
people. The sale of the securities to the supreme or highest investors is termed as distribution.

Distribution Job is given to brokers and dealers. The brokers or agents maintain direct contact with the
supreme investors.

ROLE OF THE 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.

 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.

 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.

 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.

 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.

 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.

Primary Market Reforms in India – SEBI Guidelines

1. Disclosure of All Material Facts is made Compulsory: SEBI has made it compulsory for companies do
disclose all the facts and risk factors regarding the projects undertaken by the company. The basis on
which the premium amount is calculated should also be disclosed by the company as per SEBI norms.
SEBI also advises the code of ethics for advertising in media regarding the public issue.

2. Encouragement to Initial Public 0ffers: In order to encourage Initial Public Offers (IPO) in the primary
market, SEBI has permitted companies to determine the par value of shares issued by them. SEBI has
allowed issues of IPOs to go for “Book Building” – i.e. reserve and allot shares to individual investors. But
the issuer will have to disclose the price, the issue size and the number of securities to be offered to the
public.

3. Increase of Popularity to Private Placement Market: In recent years, private placement market has
become popular with issuers because of stringent entry and disclosure norms for public issues. Besides
low cost of issuance, ease of structuring investments and saving of time lag in issuance are the other
causes responsible for the rapid growth of private placement market.

4. Underwriting has made Optional: To reduce the cost of issue in primary market, SEBI has made
underwriting of issue optional. However, the condition that if an issue was not underwritten and was
not able to collect 90% of the amount offered to the public, the entire amount collected would be
refunded to the investor is still in force.

5. Issue of Due Diligence Certificate: The lead managers have to issue due diligence certificate, which
has now been made part of the offer document.

6. Conditions regarding Application Size etc.: SEBI has raised the minimum application size and also the
proportion of each issue allowed for firm allotment to institutions such as mutual funds.

7. Regulation of Merchant Banking: SEBI has brought Merchant banking under its regulatory
framework. The merchant bankers are now to be authorized by SEBI. Merchant bankers, now have a
greater degree of accountability in the offer document and issue process.

8. Imposition of Compulsory Deposit on Companies making Public Issues: In order to induce companies
to exercise greater care and diligence for timely action in matters relating to the public issues of capital,
SEBI has advised stock exchanges to collect from companies making public issues, a deposit of one per
cent of the issue amount which could be forfeited in case of non-compliance of the provisions of the
listing agreement and, non-dispatch of refund orders and share certificates by registered post within the
prescribed time.

9. Reforms as to Mutual Funds: The Government has now permitted the setting up of private mutual
funds and a few have already been set up. UTI has now been brought under the regulatory jurisdiction
of SEBI. All mutual funds are allowed to apply for firm allotments in public issues. To improve the scope
of investments by mutual funds, the latter are permitted to underwrite public issues. Further, SEBI has
relaxed the guidelines for investment in money market instruments. Finally, SEBI has issued fresh
guidelines for advertising by mutual funds.

10. Vetting of Offer Document: SEBI vets offer documents to make sure that the company listing the
shares has made all disclosures in it. All the guidelines and regulatory measures of capital issues are
meant to promote healthy and efficient functioning of the issue market (or the primary market).