Primary Market: Meaning, Types and Functions

A primary market of the share market is where investors are offered securities for the first time. In this case, they are the direct buyers of assets and securities, meaning they sell stocks or securities as soon as they are listed on the market.

The government, companies or any other body makes its securities available on the primary market to raise money and finance their projects and businesses. Therefore, investors can obtain these stocks and shares at a relatively lower price when they are further traded on the secondary market.

Let’s move ahead and further understand what a primary market is and its functions.

What is the Primary Market?

For the first time, securities are created in a primary market to be bought by investors. In this market, capital can be raised by both the government and companies through the issue of fresh securities on a stock exchange.

Three parties are involved in a transaction on this market. This would include companies, investors, and an underwriter. A company issues securities in a primary market as an initial public offering (IPO), and the selling price of such a new issue is determined by an underwriter, which can be or cannot be a financial institution.

The new issue offers are also facilitated and monitored by an underwriter. The new securities are purchased on the primary market by investors. The Securities and Exchange Board of India regulates this market. In addition, an entity that issues securities could be looking to increase its activities, fund other business objectives, or expand its physical presence. Notes, bills, government bonds or corporate bonds, and company stocks are examples of securities issued on the primary market.

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Functions Of The Primary Market

The major functions performed by the primary market are mentioned below;

1. Underwriting Services: 

In terms of offering a new issue, underwriting plays an important role. The role of the underwriter is to purchase unsold shares if it cannot sell the required number of shares to the public. A bank may be an underwriter and receive a commission on the underwriting. Investors rely on the underwriters to determine whether the risk is worth the return. An underwriter may buy and sell all the initial public offerings to investors.

2. New Issue Offer: 

The Primary Market organises an offer to buy a new share not previously marketed on another exchange. It's also called the new issue market for this reason. A thorough evaluation of project viability and other factors involves organising new issue offers. Consideration of promoters, liquidity ratios, debt-equity ratios and foreign exchange requirements are part of the financial arrangements for this purpose.

3. Distribution of the new issue: 

A new issue has also been made available in the primary marketing area. A new prospectus issue has been launched for this distribution. It calls on the public to buy a new issue and provides detailed information concerning the company and the participating underwriters.

Types of Primary Market

Investors can buy such securities in different ways after the issue. 

1. Private Placement: 

A company offers securities to several investors, known as "private placements". Bonds, stocks or other securities may form part of the portfolio and can be held by individuals and institutional investors. It is easier to issue privately since the regulatory rules differ considerably from those in an Initial Public Offering. The costs and time of the company will also be reduced so that it can continue as a private enterprise.

Such an issuance is appropriate for start-ups or developing businesses. The company may offer this issuance to an investment bank, a hedge fund, or ultra-high-net-worth individuals (HNIs) to obtain capital.

2. Public Issue: 

A public offering is the most common way to issue a company's securities to the general public. In particular, this is carried out through the initial public offering of shares, and thus companies raise capital from the stock market. These securities shall be traded on the stock exchanges.

A privately held company becomes publicly traded when its shares are initially offered to the public via an initial public offering. A company may obtain funds to expand its enterprise, improve infrastructure and pay off debts through a public offer. The liquidity and the possibility to issue additional shares to raise capital for business are also increased by trading on an open market.
 

3. Preferential Issue: 

One of the most efficient ways to raise company capital is through preferential issues. For a limited number of investors, listed and unlisted companies may issue shares or convertible securities. The preferential issue is neither a right issues of shares nor a public issue. The dividend is payable before ordinary shareholders and holders of preference shares receive dividends.

4. Rights and Bonus Issues: 

The rights and bonus shares issue, in which an entity issues securities to existing investors by offering them the opportunity to buy additional securities at a predetermined price upon their request or take up further free shares, constitutes another type of primary market issuance.

Investors can buy low-price stocks during a defined period concerning rights issues. In addition, the rights issue provides additional control for existing shareholders and does not involve any costs associated with issuing these types of shares. Regarding bonus issues, the company issues the shares as gifts to its existing shareholders. However, new capital does not arise from the issuance of bonus shares.

5. Qualified Institutional Placement: 

A qualified institutional placement is a different category of private placement in which a listed company issues securities in the form of equity shares or partially or fully convertible debentures, aside from warrants that can be converted into equity shares and are bought by a qualified institutional buyer (QIB).

The issuance of qualified institutional placement is less complicated than preferential allotment because it is not subject to pre-issue filing requirements with SEBI. Because of this, the procedure is considerably more straightforward and takes less time.

Advantages and Disadvantages of Primary Market

The advantages of the primary market mentioned below;
 

• The cost of raising capital has been reduced. 
• There's a great deal of liquidity in securities. 
• The possibility of price manipulation is low. 
• Saves an amount that may be used to finance additional investment options.
• Not subject to fluctuations in the market.

The disadvantages of the primary market are mentioned below;

• Investors may receive all relevant information on investments once an investment is made in the initial public offering. 
• The level of risk is different from one security to another. 
• For small investors, there are better options than this.

Conclusion

A primary market is a symbolic setting where new bonds and stock certificates are issued and offered for the first time for sale to investors. They are offered for sale by the businesses, governments, or other organisations that issue them, frequently with the assistance of investment banks, which underwrite the new issues, determine their price, and manage their introduction.

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