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Primary & Secondary

Markets
Finance Notes for SEBI Grade A

Exam

For SEBI Grade A Exam

Primary & Secondary Markets Free SEBI Grade A e-book

Primary & Secondary Markets

Finance Notes for SEBI Grade A Exam

What are Primary Markets?

• The primary market is a segment of the capital market where entities such as
companies, governments and other institutions obtain funds through the sale of debt
and equity-based securities.

• When a company decides to go public for the first time by raising an Initial Public
Offering (IPO), it is done in the primary market.

• Since the securities are sold for the first time here, a primary market is also known as
the New Issue Market (NIM).

• During an IPO, the company sells its shares directly to the investors in the primary
market. The entire process of raising investment capital by selling new stock to
investors through an IPO is known as underwriting.

• Once the shares are sold, they are bought and sold by traders in the secondary market.

Functions of Primary Market

1. New Issue Offer

• This is one of the major primary market functions.

• It is this market that organises the offering of a new issue, which has not been
traded on any other exchange before.

• It’s because of this reason that the primary market is also called the new issue
market.

• There’s a lot that goes into issuing a new offer.

2. Underwriting Services

• The role of an underwriter in the primary marketplace is to buy unsold shares.

• Often financial institutions play the role of underwriters, earning a commission

in the process.
Primary & Secondary Markets Free SEBI Grade A e-book

• Often investors depend on underwriters to gauge whether undertaking the risk

would be worth the returns.

3. Distribution of New Issue

• The distribution process is initiated with a new prospectus issue.

• The public is invited at large to purchase the new issue, and detailed
information is given on the company and the issue along with the
underwriters.

Types of Issuances in the Primary Market

Once securities are issued, investors can purchase them in various ways in the primary
market. They are:

1. Public Issue

• It is one of the most common methods of issuing securities to the public at

large.

• Done primarily through an initial public offering (IPO) whereby companies

raise capital for business, the securities are then listed on the stock exchange
for trading.

• One of the features of the primary market is that a private limited company
can become a publicly traded entity through IPO.

• The capital raised by a company can also be deployed to improve the firm’s
existing infrastructure and repay debts, among others.

• It also improves a company’s liquidity.

• The Securities and Exchange Board of India (SEBI) is the watchdog that
monitors IPO, and before a firm goes for an IPO, proper enquiry is done to
establish its authenticity.

2. Private Placement

• Private placement happens when a company offers securities to a small group

of investors.
Primary & Secondary Markets Free SEBI Grade A e-book

• These primary securities may be stocks, bonds, or any other type of security.
In private placement, investors can be either institutional or individual.

• It’s easy to issue private placement compared to an IPO as the regulatory

norms are significantly less.

• Also, it incurs reduced cost and time.

3. Preferential Issues

• It is one of the quickest methods through which companies can raise capital
for their business.

• Here, both listed and unlisted companies can issue securities to a particular
select group of investors.

• It is essential to note that preferential issues are neither public nor rights
issues.

• In this type of issue, preference shareholders are paid dividends before

ordinary shareholders.

4. Qualified Institutional Placement

• It is another type of fundraising tool used by listed companies to raise capital

by issuing primary securities to qualified institutional buyers (QIBs).

• Capital market regulator SEBI introduced it to make it easier for companies to

raise capital in the domestic market.

Point to be Noted: QIBs are investors who have the requisite expertise and financial
knowledge to invest in the capital markets. They are generally foreign institutional investors
registered with SEBI, public financial institutions, and scheduled commercial banks, among
others.

5. Rights and Bonus Issues

• This is another type of issuance in the primary market.

• Here the company issues securities to existing investors by allowing them to

buy more securities at a pre-fixed price (in case of rights issue) and avail
allotment of extra shares in the case of bonus issue.
Primary & Secondary Markets Free SEBI Grade A e-book

• In the case of the rights issues, investors have the choice of purchasing stocks
at a discounted price within a specific period.

• On the other hand, in the case of a bonus issue, a firm's stocks are issued to its
existing shareholders.

Examples of Major Shares Sold in the Primary Market

In the past, several prominent companies went for IPOs in the primary market to raise capital.
For example,

1. Facebook initiated an IPO in 2012, which was one of the largest in the technology
sector Through its IPO, the company was able to raise USD 16 billion.

2. In India, Coal India undertook one of the largest IPOs in 2010, raising over ₹ 15,000
crores. Note that the company offered a discount of 5% on the final price of the IPO
to retail investors. It was also offered to subsidiaries and employees of the firm.

3. The Government of India has also initiated the process to launch the IPO of the Life
Insurance Corporation of India (LIC), expected to the biggest in the history of India’s
capital markets.

Advantages of Primary Market

1. A Cost-Effective Way to Raise Capital

• Companies can raise capital for their business cost-effectively and seamlessly
in a primary market.

• Also, securities offered in the primary market can almost be instantly sold in
the secondary market, thus providing high liquidity.

2. Fewer Chances of Price Manipulation

• As compared to the secondary market, there are fewer chances of price

manipulation in the primary market.

• This leads to better transparency and operations.

Primary & Secondary Markets Free SEBI Grade A e-book

3. Offers Diversification

• Primary market serves as a potential avenue for diversification for investors,

thus bringing down the quantum of risk.

• Investors can allocate their investments across asset classes in multiple

financial instruments.

Disadvantages of Primary Market

1. Limited Information Available to Investors

• Often there may be limited information available to investors before they

invest in an IPO.

• This is because unlisted companies are outside the purview of SEBI’s

regulations.

2. No Historical Trading Data

• As shares are issued for the first time, there’s no historical data available to
analyse the IPO shares. This can make investment a little difficult.

What are Secondary Markets?

A secondary market is also referred to as a stock market or stock exchange.

• It is a market for buying and selling existing securities. It encourages existing

investors to exit and new investors to enter the market.

• It also makes existing securities more liquid and marketable.

• It also contributes to economic growth by directing funds toward the most

productive investments via the disinvestment and reinvestment process.

• SEBI's regulatory framework governs the trading, clearing, and settlement of

securities.

• Trading through stock exchanges is now possible from anywhere in the country
through trading terminals thanks to advances in information technology.
Primary & Secondary Markets Free SEBI Grade A e-book

• There are currently 21 stock exchanges in India, including the BSE, NSE, and
OTCEI. The Securities Contracts (Regulation) Act and SEBI govern stock
exchanges.

• Along with the expansion of the country's primary market, the secondary
market has expanded significantly over the last ten years.

Components of Secondary Markets

There are two more components to the secondary markets:

1. Spot market – Here the securities are traded for immediate delivery and payment.

2. Forward market – Here the securities are traded for future delivery and payment. This
forward market is further subdivided into:

i. Futures- In the futures market, securities are traded for conditional future
delivery.

ii. Options Market (Derivatives Markets) - The options market trades two types
of options.

a. Put option gives the owner the right but not the obligation to sell a
security to the writer of the option at a predetermined price before a
certain date.

b. Call option gives the buyer the right but not the obligation to purchase
a security from the writer of the option at a specific price before a
certain date.

Types Of Secondary Markets

1. Stock Exchange

• Stock exchanges are centralized platforms where securities are traded without
any contact between buyer and seller.

• Such platforms include the National Stock Exchange (NSE) and the Bombay
Stock Exchange (BSE).

• Securities trading transactions on stock exchanges are subject to stringent

regulations.
Primary & Secondary Markets Free SEBI Grade A e-book

• A stock exchange acts as a guarantor, and counterparty risk is virtually non-

existent.

• This safety net is obtained by levying a higher transaction cost on investments

in the form of commissions and exchange fees.

2. Over the counter (OTC) Market

• Over-the-counter markets are decentralised, with participants trading among

themselves.

• In the absence of regulatory oversight, OTC markets retain higher

counterparty risks because the parties deal directly with each other.

• An example of an over-the-counter market is the foreign exchange market

(FOREX).

• In an OTC market, there is fierce competition for acquiring more volume.

Because of this factor, the price of the securities varies from one seller to
another.

Apart from the stock exchange and OTC market, there are also auction markets and dealer
markets.

3. Auction Market - It is essentially a platform for buyers and sellers to agree on the price
at which the securities will be traded. Pricing information, including the offer's bidding
price, is made available to the public.

4. Dealer Market – In this market, various dealers indicate the prices of specific
securities for a transaction. Foreign exchange and bonds are primarily traded in a
dealer market.

Secondary Market – Intermediaries

1. Stockbroker - A stockbroker is anyone who is registered with the SEBI (Stockbrokers

and Sub-Brokers) Rule, 1992 and is a member of a stock exchange. They purchase,
sell, and trade securities on behalf of investors. Angel Broking, ShareKhan and
Zerodha are examples of stockbrokers.

2. Sub-Broker - These are people who are not members of the stock exchange but work
for a stockbroker. They help investors buy, sell, and trade securities through
stockbrokers. Arihant Capital Franchise and Bezel Stockbrokers Franchise are
examples of sub-brokers.
Primary & Secondary Markets Free SEBI Grade A e-book

3. Portfolio Manager - These are the individuals who provide advice to clients or manage
a portfolio of securities or funds on their behalf. A portfolio is a grouping of securities
owned by investors.

4. Custodian - A custodian's job entails the safekeeping of a client's securities as well as

the provision of services that are incidental to such safekeeping. Many leading banks
act as custodians registered with the SEBI.

Secondary Market – Functions

• A stock exchange provides a trading platform for investors to trade bonds, shares,
debentures, and other financial instruments.

• Transactions can be entered into at any time, and the market allows for active
trading, allowing for immediate purchase or sale with little price variation between
transactions.

• Furthermore, there is consistency in trading, which increases the liquidity of assets

traded in this market.

• Investors locate a suitable platform, such as a regulated exchange, to liquidate their

holdings. They can sell the securities they own on various stock exchanges.

• A secondary market serves as a medium for determining asset pricing in a transaction

that is consistent with demand and supply.

• The information about transaction prices is in the public domain, allowing investors to
make informed decisions.

• It is also indicative of a country's economy and serves as a link between savings and
investment. Savings are mobilized through investments in the form of securities.

Secondary Market – Benefits

• When investors require funds, the secondary market allows them to recover a portion
of their initial investment.

• The secondary market allows investors to earn a high return by investing for a longer
period of time.

• Investors can conveniently solve their liquidity problems in a secondary market. For
example, an investor in need of liquid cash can easily sell the shares he or she owns
because the secondary market is flooded with buyers.

• The secondary market serves as a guideline for determining a company's fair value.
Primary & Secondary Markets Free SEBI Grade A e-book

• Price adjustments of securities in a secondary market occur quickly in response to the

availability of new information about the company.

• Due to the strict regulations that govern the secondary stock market, investors' funds
are relatively safe.

• The regulations are strict because the market provides liquidity and capital formation
for both investors and businesses.

• When investors' money is held in the form of securities, it becomes easier to mobilize
savings.

Secondary Market – Limitations

• Prices of securities in a secondary market are subject to high volatility, which can
result in a sudden and unexpected loss for investors.

• Before buying or selling in a secondary market, investors must go through

the necessary procedures, which can be time-consuming.

• Brokerage commissions levied on each transaction of buying or selling securities

may reduce investors' profit margins.

• Investments in a secondary capital market are high risk due to the influence
of multiple external factors, and the current valuation can change in a matter of
minutes.

Difference Between Primary and Secondary Markets

Primary Market (New issue market) Secondary Market (Stock exchange)

1. There is a sale of securities by new 1. Existing shares are the only ones that can
companies or further (new issues of be traded.
securities to investors by existing
companies).
2. The company sells securities directly to the 2. Investor’s exchange ownership of
investor (or through an intermediary). existing securities. The company is not
involved in any way.
3. The flow of funds is from savers to 3. Increases share encashability (liquidity),
investors, implying that the primary market implying that the secondary market
promotes capital formation directly. indirectly promotes capital formation.
4. The primary market only allows for the 4. The stock exchange allows for both the
purchase of securities; it does not allow for buying and selling of securities.
the sale of securities.
5. The company's management determines 5. Prices are determined by the securities
and decides on prices. demand and supply.
Primary & Secondary Markets Free SEBI Grade A e-book

6. It does not have any fixed geographic 6. Located in specific locations.

location.

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