Chapter 10 (a):

Primary Markets and the

Underwriting of Securities
Chapter 10 (a) : Primary Markets and the Underwriting of
Securities
The mechanism of dealing with financial claims that are newly issued is
primary market. This market involves the distribution to the investors of newly
issued securities by the government, municipal governments and corporations.
The traditional process for issuing new securities: The traditional process
involves investment bankers performing one or more of the following
functions:
(I) advising the issuer on the terms and timing of the offering,
(ii) buying the securities from the issuer and
(iii) distributing the issue to the public.
The general process of a typical common stock
underwriting operation might be as follows:
1. Underwriter Selection
2. Advice and Counsel
3. Registration
4. Syndicate Formation
5. Price Setting
6. Fee Distribution
7. Price Stabilization
8. Quiet and Lock-up Periods
Shariah Screening in Islamic Stock Market
These are the markets where companies have to go through some
specific Shariah screening process to be qualified for trading their
shares in these markets. The existence of the Shariah screening process
in the financial market enables investors to invest in companies that
operate permissible business activities in accordance with fair Islamic
principles. The major two criteria for this screening are discussed
below:

1. Nature of Business: While certain activities are accepted as Shariah

compliant, Shariah scholars have started to question the allowance of
share trading of companies whose core activity is lawful but that
occasionally get involved in unlawful transactions. These companies
are in mixed activities with some non-compliant businesses are
considered as joint stock companies. This is mainly because the
inclusion of joint stock companies plays an important role to the
development of Islamic finance.
Shariah Screening in Islamic Stock Market
2. Financial Structure: The second major screening criterion
examines the financial structure of the business and benchmark
against some collectively agreed level of tolerance. Financial structures
of companies are measured to gauge the involvement of these
companies in non-permissible practices. Involvement in Riba is
measured by the companys interest-based income as well as their
interest payment for debt which is termed as interest screen and debt
screen. It is also claimed that money in itself is not a permissible asset
in accordance with the Islamic Shariah principles. The level of liquid
assets which may include cash and cash equivalents, short term
investments and accounts receivables should be kept to a minimum in
Islamic finance.
Terminologies:
01. Underwriting and underwriter Different types of services
provided by an individual or institution to an issuing business
for issuing financial assets are known as underwriting and the
third party provides services to an issuing business is known as
underwriter.

02. Registration statement Statements submitted by the issuer

to SEC according to Sec Act. for getting registration containing
nature of the business of the issuer, key provisions or features of
the security, the nature of the investment risks associated with
the security, the background of management and certified
financial statements are known as registration statement.
Terminologies:
03. Waiting period the time interval between the initial
filing of the registration statement and the time the
registration statement becomes effective is referred to as
waiting period.

04. Bought deal underwriting The lead manager or a group

of managers offers a potential issuer of debt securities a firm
bid to purchase a specified number of securities with a
certain interest rate and maturity. The issuer is given a day or
so to accept or reject the bid. If the bid is accepted, the
underwriting firm has bought the deal. It can in turn, sell the
securities to other investment banking firms for distribution
to their clients or distribute the securities to its clients.
Terminologies:
05. Auction process The issuer announces the terms of the
issue and interested parties submit bids for the entire issue. The
auction form is mandated for certain securities of regulated public
utilities and many municipal debt obligations. In this process, the
bidders indicate the price they are willing to pay and the number
of securities they are willing to buy. The security is then allocated
to bidders from the highest bid price to the lower ones until the
entire issue is allocated. For example, an issuer is offering Tk.500
million of a bond issue and nine bidders submit the following
yield bids:
The first four bidders A, B, C and D will be allocated the
securities for lowest yield and remaining Tk.50 million will be
allocated to E and F proportionately.
Bidder Amount in million Bid yield (%)

A 150 5.1
B 110 5.2
C 90 5.2
D 100 5.3
E 75 5.4
F 25 5.4
G 80 5.5
H 70 5.6
I 85 5.7
Terminologies:
06. Preemptive rights offerings It grants existing shareholders the
right to buy some proportion of the new shares issued at a price below
market value. The price at which the new shares can be purchased is
called the subscription price. The value of right can be determined by
calculating the difference between the price of a share before the rights
offering and the price of a share after the rights offering. That is,

Value of a right = Price before rights offering Price after rights offering
or Share price on rights Share price ex rights.

Example, capitalization of a company is Tk.600000 against 30000 shares

with Tk.20 per share price. Now the company issues right shares in the
ratio of 3:1 for Tk.17 per share. Number of shares is 40000 and
capitalization is Tk.770000. After rights issue price per share is Tk.19.25
(Tk.770000/40000). So, value of a right is Tk.0.75 (Tk.20-Tk.19.25).
Terminologies:
07. Initial Public Offering: Issue of financial instruments for the first
time to the public by a firm is called initial public offering.

08. Private Placement: Issuing of new securities to the few wealthy or

institutional investors without circulating prospectus by the issuing
firm is called private placement.

09. Investment banker: The individual or institution providing

advisory, underwriting or marketing services as a third party to the
issuing business for issuing new securities in the market to the public is
called investment banker.

10. Red herring: To highlight the important information by coloring,

making italic, capital letter or blackening in the prospectus circulated
in the news papers for informing general public about initial public
offering is known as red herring.
Terminologies:
11. Prospectus: The statement/document published in the daily news
papers for informing the general public about the issuing of new
securities is called prospectus.

12. Firm commitment underwriting: The underwriting agreement

where the underwriter is committed to subscribe the unsubscribed
securities is known as firm commitment underwriting.

13. Best efforts underwriting: The underwriting agreement where the

underwriter is not committed to subscribe the unsubscribed securities
but is committed to apply best efforts to sell securities to the public is
known as best efforts underwriting.

14. Shelf registration: To take permission from proper authority for

issuing new securities for raising long-term fund in future phase by
phase for minimizing floatation cost and waiting of time is called shelf
registration.