Capital Market: Primary and Secondary Markets
1. Primary Market (New Issue Market):
Primary market is also known as new issue market. As in this market securities are sold for the first time, i.e., new securities are issued from the company. Primary capital market directly contributes in capital formation because in primary market company goes directly to investors and utilises these funds for investment in buildings, plants, machinery etc.
The primary market does not include finance in the form of loan from financial institutions because when loan is issued from financial institution it implies converting private capital into public capital and this process of converting private capital into public capital is called going public. The common securities issued in primary market are equity shares, debentures, bonds, preference shares and other innovative securities.
Method of Floatation of Securities in Primary Market:
The securities may be issued in primary market by the following methods:
- Public Issue through Prospectus:
Under this method company issues a prospectus to inform and attract general public. In prospectus company provides details about the purpose for which funds are being raised, past financial performance of the company, background and future prospects of company.
The information in the prospectus helps the public to know about the risk and earning potential of the company and accordingly they decide whether to invest or not in that company Through IPO company can approach large number of persons and can approach public at large. Sometimes companies involve intermediaries such as bankers, brokers and underwriters to raise capital from general public.
- Offer for Sale:
Under this method new securities are offered to general public but not directly by the company but by an intermediary who buys whole lot of securities from the company. Generally the intermediaries are the firms of brokers. So sale of securities takes place in two steps: first when the company issues securities to the intermediary at face value and second when intermediaries issue securities to general public at higher price to earn profit. Under this method company is saved from the formalities and complexities of issuing securities directly to public.
- Private Placement:
Under this method the securities are sold by the company to an intermediary at a fixed price and in second step intermediaries sell these securities not to general public but to selected clients at higher price. The issuing company issues prospectus to give details about its objectives, future prospects so that reputed clients prefer to buy the security from intermediary. Under this method the intermediaries issue securities to selected clients such as UTI, LIC, General Insurance, etc.
The private placement method is a cost saving method as company is saved from the expenses of underwriter fees, manager fees, agents’ commission, listing of company’s name in stock exchange etc. Small and new companies prefer private placement as they cannot afford to raise from public issue.
- Right Issue (For Existing Companies):
This is the issue of new shares to existing shareholders. It is called right issue because it is the pre-emptive right of shareholders that company must offer them the new issue before subscribing to outsiders. Each shareholder has the right to subscribe to the new shares in the proportion of shares he already holds. A right issue is mandatory for companies under Companies’ Act 1956.
The stock exchange does not allow the existing companies to go for new issue without giving pre-emptive rights to existing shareholders because if new issue is directly issued to new subscribers then the existing equity shareholders may lose their share in capital and control of company i.e., it would water their equity. To stop this the pre-emptive or right issue is compulsory for existing company.
- e-IPOs, (electronic Initial Public Offer):
It is the new method of issuing securities through on line system of stock exchange. In this company has to appoint registered brokers for the purpose of accepting applications and placing orders. The company issuing security has to apply for listing of its securities on any exchange other than the exchange it has offered its securities earlier. The manager coordinates the activities through various intermediaries connected with the issue.
2. Secondary Market (Stock Exchange):
The secondary market is the market for the sale and purchase of previously issued or second hand securities.
In secondary market securities are not directly issued by the company to investors. The securities are sold by existing investors to other investors. Sometimes the investor is in need of cash and another investor wants to buy the shares of the company as he could not get directly from company. Then both the investors can meet in secondary market and exchange securities for cash through intermediary called broker.
In secondary market companies get no additional capital as securities are bought and sold between investors only so directly there is no capital formation but secondary market indirectly contributes in capital formation by providing liquidity to securities of the company.
If there is no secondary market then investors could get back their investment only after redemption period is over or when company gets dissolved which means investment will be blocked for a long period of time but with the presence of secondary market, the investors can convert their securities into cash whenever they want and it also gives chance to investors to make profit as securities are bought and sold at market price which is generally more than the original price of the securities.
This liquidity offered by secondary market encourages even those investors to invest in securities who want to invest for small period of time as there is option of selling securities at their convenience.