Primary market: What is it and how does it work?

The primary market is where securities are issued and initially sold before they start trading on secondary markets. It enables businesses to raise capital by offering shares or bonds to investors. The primary market lays the foundation for subsequent trading of issued securities in the secondary market. Understanding how the primary market works can help you make informed investment decisions when securities are first issued.

• Table of contents

1. Primary market definition
2. The working of a primary market
3. Types of primary markets
4. Primary market functions
5. Benefits of the primary market
6. Limitations of the primary market
7. Types of primary market issuance
8. Factors to consider for primary market investment

Primary market definition

The primary market refers to the process by which a company or government issues new security offerings like stocks and bonds to raise funds from investors. It is the market where securities are created and sold to initial buyers. The money thus raised goes directly to the issuing entity enabling capital formation.

Also Read: The world of stock trading: Definition, forms and history

The working of a primary market

In the primary market, issuers like companies and governments approach investors to buy their newly issued securities. The steps are below.

1. The issuer decides to raise capital through the sale of securities like shares or bonds.
2. It appoints an investment bank as the underwriter to manage the issuance process.
3. The underwriter advises on the offering size, timing, structure and price of the issue.
4. The securities are directly sold to institutional investors, high net worth individuals and retail investors.
5. The issuer receives funds from the primary issue while investors gain ownership of the securities.
6. The securities are then listed on a stock exchange for trading in the secondary market.

Thus, the primary market channels savings into productive investments to aid business growth and economic activity. It also provides an exit route for initial investors.

Types of primary markets

There are two main types of primary markets.

Public offerings

Securities are offered to the general public, including both institutional and retail investors. For example, an initial public offering or IPO.

Read Also: What is IPO: Meaning, types, working, eligibility & benefits

Private placements

Securities are allotted to select investors like banks, mutual funds and wealthy individuals. For example, a preferential allotment.

Public offerings get wider participation while private placements allow greater control over targeting investors. Issuers opt for either method based on factors like purpose of raising funds, regulatory costs and current market conditions.

Primary market functions

The primary market fulfils critical important economic functions. Below are some.

• Provides capital for business growth and expansion.
• Enables investors to acquire ownership as part-owners in companies.
• Democratises the capital-raising process through public offerings.
• Adds liquidity through listing of securities on stock exchanges.
• Indicates real-time valuation based on demand for the issue.
• Facilitates subsequent trading in the secondary market.

The primary market sets into motion the entire capital market ecosystem. It also redistributes wealth among economic participants.

Benefits of the primary market

• Gain ownership early at the IPO offer price.
• Participate in the company's future capital appreciation.
• Diversify your portfolio with new offerings.
• Gain exposure to unique assets or businesses.
• Support upcoming enterprises and innovation.
• Benefit from incentives like discount on issue price for retail investors.

The primary market allows putting your capital to use for economic growth. It also provides incentives that may not be available later.

Limitations of the primary market

• Lack of historical price data or track record.
• Difficult to estimate the true valuation.
• Higher volatility and speculation during initial trading.
• Delayed listing and lower liquidity initially.
• Subject to a lock-in period preventing sale.
• Need to rely on prospectus and expert advice.
• Limited access for retail investors

Primary market investments require careful analysis, longer holding capability and sizable risk appetite.

Types of primary market issuance

Factors to consider for primary market investment

• Company's business model, industry dynamics and competitive position.
• Management credibility and corporate governance standards.
• Company's operating and financial performance.
• Intended use of the raised capital and growth strategy.
• Indicative valuation based on earnings, net asset value, comparisons etc.
• Risk factors specific to the company or the sector.
• Prospects of becoming a future bluechip if listing gains traction.

Getting in early into the right companies at a good price can be rewarding in the long run.

Conclusion

The primary market fulfills the crucial economic functions of capital formation and wealth redistribution. Though relatively riskier, it offers incentives, transparency and growth opportunities to investors. With prudent analysis, the primary market can aid portfolio growth and exposure to upcoming industries. Overall, it forms the fountainhead energising entire capital markets.

FAQs

What are the types of primary market issues?

The main types of primary market issues are initial public offerings, follow-on offerings, rights issues, preferential allotment, qualified institutional placements and initial coin offerings.

Who can invest in the primary market?

Both institutional investors like banks, mutual funds and high net worth individuals, as well as retail individual investors can invest in securities issued through the primary market. However, entry costs are often high, making access retail investors limited.

Can I invest online in the primary market?

Yes, one can submit applications online for IPOs, FPOs and other public issues through brokers who provide this facility. Online applications have made primary market investments easier.

Is the primary market separate from the secondary market?

Yes, the primary market is the avenue for new issuances through IPOs etc. while the secondary market like NSE or BSE is where already issued securities are traded among investors and speculators.

What is a primary and secondary market?

The primary market is where securities are first sold by an issuing entity directly to investors. The secondary market is where previously issued securities are traded among investors and speculators. The secondary market provides liquidity and price discovery.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.