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All About Primary Market and secondary market

Amit: Uncle, we understood in order to buy shares, one must have bank, demat and trading account. But how do we exactly buy share/stock?

Uncle: Amit and Sarvo, Lets revise quickly, first we understood what is share, what is share market/stock exchange, how trade cycle gets completed. Then we discussed about prerequisite requirement i.e. Demat Account, Trading account. Now let’s go 1 step ahead and discuss about 2 ways to buy share.

So, there’s only two ways you can buy a stock.

1. IPO’s or initial public offers (Also called primary market)

2. Through stock markets – those gigantic auction houses where millions of shares are exchanged. (Also called secondary market) 

Primary Market

As you know, business requires money in order to grow and expand and they can raise money in the form of equity or debt. Such business entities may then approach public at large/institutional investors (banks, financial institution, MF House) for raising money. Business entity raises money from investors by issuing newly created securities or may sell securities already held by some investors. This is Primary Market transaction. 1. Public Issue

When a company raises funds by selling (issuing) its shares (or debenture / bonds) to the public through issue of offer document (prospectus), it is called a public issue.

 IPO(Initial Public Offer)

As the name suggests, IPO’s are fresh issue of shares to the public. When a (unlisted) company makes a public issue for the first time and gets its shares listed on stock exchange, the public issue is called as initial public offer (IPO). This process is undertaken at the primary market.   

Sarvajeet: Uncle, how do I apply to public Issue?

Uncle: Sarvo, when a company comes with an IPO, it prints and circulate/distribute IPO application forms among the investors.  To subscribe to an IPO, Investors have to fill an application form. These forms are available with syndicate members, brokers, sub-brokers, investment advisors and stalls outside stock exchanges, banks and with vendors in various other areas. Once you get the forms, you have to fill it, remit the amount after calculating the number of shares applied for the bank that is designated in the form as collecting centre for that IPO. Investors have to provide the details of their demat account and bank account in the form.

Amit: How do I decide on a good new issue?

Uncle: This is important, especially when a large number of new companies are floating public issues. While a large number of these companies are genuine, quite a few may want to exploit investors. An investor must therefore, identify the exploit investors. An investor must therefore, identify the future potential of a company before applying for its issue.

A part of the guidelines issued by the SEBI (Securities and Exchange Board of India- Regulator) is the disclosure of information to the public. This disclosure allows the public to know the reason for raising the money, the new way the money is proposed to be spent, the returns expected on the money and so on.

This information is in the form of a prospectus, which includes information regarding the size of the issue, the current status of the company and its credibility, its equity capital, its current and past performance, promoters, the project, cost of the project, means of financing, product and capability.

New issue also contains a lot of mandatory information regarding underwriting and statutory compliances. This gives the investor a fair chance to evaluate the prospectus of the company in the short and lot term period and make investment decision.

Sarvajeet: Uncle what should a layman look for in the prospectus?

Uncle: The important factors to be considered are:

  • Promoters, their credibility and track record
  • Past performance of the company
  • Products of the company and future potential of a products
  • Technology tie-up, if any, and the reputation of the collaborators
  • Project cost, means of financing and profitable projections
  • Risk factors
  • Rating given by a credit rating agency

FPO (Further public offer)

Existing companies, who have already issued shares, may require additional money for further expansion. If they wish, they can tap if from the primary market. Such share issues will be called ‘follow on issues’.

2. Offer for sale

 Institutional investors like venture funds, private equity funds etc. invest in unlisted company when it is very small or at an early stage. Subsequently, when the company becomes large, these investors sell their shares to the public, through issue of offer document and the company’s shares are listed in stock exchange. This is called as offer for sale. The proceeds of this issue go the existing investors and not to the company.

3. Rights issue (RI)

 When a company raises funds from its existing shareholders by selling (issuing) them new shares / debentures, it is called as rights issue. The offer document for a rights issue is called as the Letter of Offer and the issue is kept open for 30-60 days.

Existing shareholders are entitled to apply for new shares in proportion to the number of shares already held.  For e.g. in a rights issue of 1:5 ratio, the investors have the right to subscribe to one (new) share of the company for every 5 shares held by the investor.

 This is all about primary market. Now let’s discuss in brief about secondary market.

Secondary market

Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market. Secondary market comprises of equity markets and debt markets. Secondary market provides liquidity for shares issued in the primary market and determines the fair prices of the security. The platform for trading is provided by the stock exchanges which are recognized by SEBI.

 

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