Do you know the place in the financial market where companies and governments raise capital to fuel their growth and investors get the first opportunity for their new investments? This place is called the primary market, where securities are issued for the first time.
This place connects investors with IPOs, bonds, and other financial instruments issuers. In this blog, we will delve into the concept of what is primary market, how it works, its importance, benefits and risks and more.
What is Primary Market?
Often referred to as the “New Issue Market”, the primary market meaning is where a company or government initially issues its securities to raise capital. It helps both the government and companies to raise funds from investors.
Generally, when a transaction occurs in this market, three entities are involved, namely investors, the issuing entity and an underwriter. The underwriter can be a financial institution that decides the selling price of the new securities.
An underwriter also manages and oversees the issuance process. Investors purchase these newly issued securities in this market, which is regulated by the Securities and Exchange Board of India (SEBI).
How Does the Primary Market Works?
After understanding primary market definition, here is how the primary market actually works:
- The organisations issue new securities in the primary market to raise capital for various purposes, such as expanding their business or financing specific projects.
- The process is heavily regulated to ensure transparency and fairness, applying strict rules for every transaction in the primary market.
- Before offering securities to the public, companies must submit necessary filings and documents to the Securities and Exchange Board of India (SEBI) to ensure transparency and maintain market integrity.
- The primary market transaction concludes when investors buy all the bonds or shares (up to the offer size). After that, if you want to invest in these securities, you can buy them from the secondary market where the transaction occurs among buyers and sellers.
Difference Between the Primary Market and the Secondary Market
By following this table, you will easily understand the difference between a primary and a secondary market:
| Aspect | Primary Market | Secondary Market |
| Definition | This is the place where the new securities are issued and sold first. | A market where existing securities are bought and sold among investors. |
| Involvement of Issuer | The issuer has direct involvement in selling securities to the first investors. | The issuer has no direct involvement in the trading of securities. |
| Purpose | To raise new capital for the issuer by selling securities. | It gives a platform and liquidity to trade existing securities. |
| Participants | There are two types of participants– Issuers (companies, governments) and initial investors. | General investors, including both retail and institutional buyers and sellers. |
| Type of Transaction | Selling securities for the first time often through IPOs or private placements. | The existing investors buy and sell securities in this market. |
| Examples | Initial Public Offerings (IPOs), bond issuances. | Stock exchanges like NSE and BSE are where bonds, stocks, and other assets are traded. |
Different Types of Securities Available in the Primary Market
These are some of the commonly issued securities issued in the primary market:
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Stocks or Shares
Shares or stocks are considered as ownership in a company. Generally, a privately owned company launches their initial public offering (IPO) to raise funds from public investors. Through this process, the companies sell their ownership to the public for the first time.
The fund a company raise from its IPO either goes to its existing shareholders (Offer For Sale), directly to the company (Fresh Issue) or both. If the company is getting the funds, they can use it for paying off debt, business expansion, R&D, or other financial requirements. To invest in IPOs, you need to have a Demat account.
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Bonds
The bond is a type of debt instrument that governments or companies issue to raise funds at affordable interest rates and without selling their shares. The bondholders get regular interest payments and return the principal amount after the maturity.
Companies can issue bonds in the primary market in both private placements and public offerings.
Generally, governments issue bonds to finance public infrastructure projects or cover budget deficits, while companies issue corporate bonds to support their operations or make investments.
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Debentures
Debentures are similar to bonds but are unsecured as there is no collateral. In the primary market, companies issue debentures to raise funds for various business activities.
Compared to bonds, debentures have higher risk as there is no collateral, and to attract investors, they offer interest rates.
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Convertible Securities
Convertible securities such as convertible stocks and bonds are hybrid investment instruments that allow you to convert them into common shares under some conditions or at a specific time. The number of shares you get is predetermined.
A company issues convertible securities in the primary market to raise funds while providing investors with the potential for capital appreciation by converting to common shares.
The Significance of the Primary Market
The primary market has a different significance for investors and the issuers, like:
- Raising Capital: The primary market enables companies to secure funds for expansion, new projects, or debt repayment by issuing new securities.
- Facilitating Risk Transfer: Companies transfer financial risk to investors who purchase newly issued securities and reduce the company’s risk in exchange for potential returns to investors.
- Price Discovery: The new issues market helps determine the fair market value of newly issued securities, ensuring investors pay a fair price through mechanisms like IPOs.
- Providing Investment Opportunities: The primary market offers various investment options, including equity shares, bonds, and other debt instruments that allow you to diversify your portfolio and meet financial goals.
Advantages and Risks of Investing in the Primary Market
Here are the advantages of the primary market:
- Primary markets allow companies to raise capital at a low cost.
- Securities issued in the primary market are highly liquid, as the investors can easily trade them in the secondary market.
- The primary market minimises the chances of price manipulation compared to the secondary market.
With some advantages, there are also some risks of investing in the primary market such as:
- Unlisted companies are not subject to the Securities and Exchange Board of India’s (SEBI) regulatory and disclosure requirements which limit an investor’s access to information before investing in an IPO.
- IPO shares carry varying degrees of risk, and as they are going public for the first time, without any historical trading data available for analysis.
- Small investors may not always benefit from an IPO, as they may not receive allocations if the subscription rate exceeds the offer size.
Examples of Primary Markets
The primary market plays a crucial role in capital formation by enabling companies and governments to issue new securities to raise funds. Let’s explore some well-known examples of primary markets and how they function:
- Initial Public Offerings (IPOs)
IPOs represent one of the most recognised examples of the primary market. A company offers its shares to the public for the first time through an IPO to raise equity capital. For instance, when LIC of India launched its IPO in 2022, it provided retail and institutional investors an opportunity to invest directly in the company. The funds raised are typically used for business expansion, debt reduction, or other strategic objectives.
- Government Bond Issues
Governments issue bonds in the primary market to finance public infrastructure projects, manage fiscal deficits, or meet other public expenditure needs. For example, Government of India issues securities like Treasury Bills (T-bills) or dated government bonds, which are subscribed by institutional investors, banks, and individuals. These securities provide a secure investment avenue while supporting national development.
- Corporate Bonds and Debentures
Companies raise debt through corporate bonds and debentures in the primary market to fund operations, projects, or refinance existing debt. A notable example is when large corporations like Reliance Industries or Tata Motors issue non-convertible debentures (NCDs) to institutional and retail investors.
- Private Placements
Another example of a primary market transaction is private placement, where securities are sold directly to a small group of investors, such as mutual funds, pension funds, or high-net-worth individuals. This method is quicker than a public issue and is often used for raising capital efficiently without a full public offering.
These examples demonstrate how the primary market serves as the first stop for raising fresh capital, offering investors opportunities to participate in the growth journeys of companies and governments.
Final Words
Having a clear understanding of what is the meaning of primary market is crucial before investing in the stock market. The primary market plays a vital role in the Indian financial system, acting as the gateway for companies and governments to raise capital. However, you as an investor must be aware of the possible challenges, including market risks and information mismatch.
A clear understanding of the primary market’s functions, benefits, and drawbacks is important for both issuers and investors to make well-informed financial decisions in this financial landscape. Are you planning to invest in an IPO? Well, create a free Demat Account at Torus Digital and start trading!
