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FMO Module 2
FMO Module 2
PRIMARY MARKET
Introduction
This is the market for the issue of shares for the first time. This is not a specific place.
Instead of that it extends to all places where the shares, debentures bods or other
securities can be subscribed for he firs time. Merchant bankers, underwriters
brokers and investors are the part of this market. Primary market is defined as the
part of capital market that deals with issuing of new securities.
The new issue market mobilizes the resources from savers and transfers them to the
users like companies and the governments for for setting up new projects. The new
issue market performs these functions through three main services such as
origination, underwriting and distribution
1. Origination
This function is performed usually by merchant bankers who are teh sponsors to teh
issue of securities. They advise the company on the types of securities ot be issued,
the quantity of shares to be issued, the time of issu, their pricing etc.
2. Underwriting
Underwriter is the person who agrees to subscribe the securities issued which are
not subscribed by the public. Underwriting is actually a guarantee that the shares
would be marketed and the proposed project would be financed. For their services
the underwriters get commission which is called underwriting commission.
d. Firm underwriting: Here the underwriter agrees to buy certain number of shares
issued irrespective of subscription by the public.. Underwriter is liable for shares
underwritten and the part of issue unsubscribed by the public.
1. Public issue
2. Private placement
3. Rights issue
4. Bonus issue
5. Employees Stock Option Plan (ESOP)
Public Issue:
Public issue refers to the issue of securities to the general public. They are getting a
chance join the shareholders’ family of the company. The public issue is further
classified into:
a. Initial Public Offer: IPO refers to issue of shares to the public for the first time by
an unlisted or newly floated company. It is actually the first sale of shares to the
public by the company. The IPO of Coal India Limited is considered to be the biggest
IPO. It was for Rs 15000 Crore.
e -IPO
If the company makes public issue shares through on line system of stock exchange it
is called e - ipo. This swill provide for online submission of bids by investors from the
terminal of stock brokers.
The methods of offering a public issue can be of two types They are:
i. Offer through Prospectus and
ii. Offer for Sale.
The issuing company decides the price of shares. There two methods of assigning
price to the securities. They are fixed price and book built price.
The issuing company after consultation with the merchant banker deides the price of
the issue and discloses the same in the prospectus.
Book built issue: Here only the price band is mentioned in the prospectus and the
prospectus in such situation is called Red herring prospectus. In the price band there
will be the floor price and cap price and the demand decides the price which should
be fixed. On the basis of final price decided by market demand the bids are
evaluated and successful bidders get the allotment.
Categories of investors
Three categories of investors who can participate in the public issue are:
These investors apply for bids for public issue for an amount not more than Rs 2
lakhs. An investor who applies for bid in excess of this amount will be treated as Non
Inquisitional Investors.
They are institutional investors in the securities market. Financial institutions such as
commercial banks, mutual funds, pension funds, insurance companies come under
this category.
Green shoe option is a post listing price stabilization mechanism.The term related to
a company in the USA which first exercised this option. The name of the company
Green Shoe Manufacturing Company. This option allow the companies offering IPO
to intervene in the market to ensure that teh share price does not fall below the
issue price during the 30 day stabilization period immediately after listing.
This clause allows the underwriters to buy additional 15% of shares of the company
at offer price. To keep the price under control the underwriter oversells or shorts up
to 15% more shares than initially offered by the company.
Exercising this option involves purchasing or selling of equity shares from the market
by the underwriter in case the share price falls below or significantly goes above the
issue price.
3. Private Placement
The companies can sell securities outright to selected group of persons. This is
known as Placement or Private Placement.. When the issuing company issues
securities to a selected group of persons not exceeding 200, it is called private
placement. In private placement the promoters sells a portion of the issue to friends
or financial institutions.
a. Preferential Issue
Preferential Issue means an issue of specified securities by a listed issuer to any
select person or group of persons on a private placement basis. This issue can be
made only on passing a special resolution in the shareholders’ meeting.
The price of issue should be teh price higher of the average o f the weekly high and
low of the closing price of related shares during the six and half weeks preceding the
relevant date.
The price of issue should be the price higher of the average o the weekly high and
low of the closing price of related shares during the six and half weeks preceding the
relevant date.
4. Rights Issue
5.Bonus issue
Bonus issue refers to the issue of shares free to the existing shareholders. The bonus
can be given to them either in cash or or in shares. Bonus given in shares is called
bonus shares. Bonus issue is done when the reserves exceed the paid up capital of
the company. In such a situation a portion of the reserves are capitlaised. That is why
bonus issue is otherwise known as capitalization of reserves. The declaration of
bonus issue in-lieu of dividend should never be made by the company.
ESOP is an option given by the company to its full time directors or employees to buy
the shares of the company at a pre- determined price on a future date. The shares
are offered usually at a price lower than the market price. This is given as
consideration for their valuable contributions to the company. The main objective of
ESOP is to retain, reward or motivate the employees. The option given to the
employee should not be transferred. The price payable by the employee to exercise
the option is known as exercise price.
Types of ESOP, Methods of pricing issue, difference between fixed price issue an d
book built issue (pg 67 and 68)
Merchant bakers are those people who make arrangement for selling buying or
subscribing to the securities as manager, consultant or advisor to issue. They are the
most important intermediaries in the new issue market. The SEBI regulations 1992
states that every public issue should be managed by at least one merchant banker.
There can be more than one merchant banker. If the size of issue exceeds Rs 40
crore there can be five or more merchant bankers
A public issue is successful only if it has achieved the minimum subscription of 90%.
If the minimum subscription is not achieved, the entire application money received
should be refunded to those who applied for shares. Here the underwriters come to
the rescue of the company. They agree to subscribe to the unsubscribed part of the
shares issued.Underwriters are appointed by the company in consultation with the
managers to the issue. Financial institutions, members of stock exchanges,
commercial banks, investment companies etc can act as underwriters.
Brokers are persons authorized to market the issue of securities. Companies can
engage any number of brokers for this purpose. Brokers to the issue are not
mandatory. But their expertise help the company in marketing the shares.
Remuneration of the brokers is fixed by SEBI. Hedge Equities, Geojith BNP Paribas,
UAE Exchange and Finance Limited are few examples of brokers.
Bankers to the issue collect the application forms and the application money in cash,
cheque or ASBA. There can be many collection centers. The bankers to the issue will
transfer all the applications received to the registrar to the issue on completing the
subscription date. Bankers to the issue also helps in the marketing of securities.
6.Syndicate members
Syndicate members are commercial or investment banks which are registered with
SEBI. They also carry out the activities of underwriting in IPO. They play a crucial role
in book built issue, They are appointed by book runners to assist them. The syndicate
members enter the bids of the investors in the book building system and also act as
underwriters. They circulate the copies of Red Herring prospectus along with the
application forms to the potential investors.
7.Advertisers
The companies engaged in public issue have to do advertisement in the national and
local dailies before the issue commences.
8.Depositories
operations, depositories should get registration from SEBI. Presently there are two
depositories working in the field. They are National Securities Depository Limited
and Central Depository Services Limited.
Depository Receipts
GDR is in USD. It is traded in Europe or USA. These are certain number of equity
shares. They are issued through depositories.
Yankee Bonds
Yankee bonds are dollar denominated bonds issued in the USA bond market by a
non American company. Yankee bonds help issuers to take advantage of favourable
lending conditions in the US. Reliance has issued Yankee bonds for collecting $100
Million for a maturity period of 50 years.