CBSE Class 11 Financial Markets Primary market

Primary Market

2.1 Primary Markets

Companies raise funds to finance their projects through various methods. The promoters can bring their own money of borrow from the financial institutions or mobilize capital by issuing securities. The funds maybe raised through issue of fresh shares at par or premium, preferences shares, debentures or global depository receipts. The main objectives of a capital issue are given below:

To promote a new company

To expand an existing company

To diversify the production

To meet the regular working capital requirements

To capitalize the reserves

Stocks available for the first time are offered through primary market. The issuer may be a new company or an existing company. These issues may be of new type or the security used in the past. In the primary market the issuer can be considered as a manufacturer. The issuing houses, investment bankers and brokers act as the channel of distribution for the new issues. They take the responsibility of selling the stocks to the public.

2.1.1 The Function

The main service functions of the primary market are origination, under writing and distribution. Origination deals with the origin of the new issue. The proposal is analyzed in terms of the nature of the security, the size of the issue, timing of the issue and floatation  method of the issue. Underwriting contract makes the share predictable and removes the element of uncertainty in the subscription (underwriting is given in the latter part of this chapter). Distribution refers to the sale of securities to the investors. This is carried out with the help of the lead managers and brokers to the issue.

2.1.2 The Rise and Fall of Primary Markets

Only a few years back, any investor worth his salt thought that investing in primary issues was the easiest and simplest way to make money. He scoffed at other "inferior" options like mutual funds and bank deposits because they did not double or triple his money in a few months time! Believe it or not, primary markets did that precisely - they posted near indecent returns like 300 to 400% just in two months time. When the common investor benchmarked all other investment options against these phenomenal returns, obviously they stood no chance. Returns apart, investing in primary issues appeared so simple and "risk free"! All that was required of investors to partake in the manna was to simply put as large an application as possible because the proportionate allotment rule worked to the favor of big investors (small investors were supposed to have gone to mutual funds) and pray for a large allotment. Once they received some shares on the large subscription, they just offloaded their holdings at the listed prices, which were at a hefty premium to the issue price not because of any good fundamentals of the issuing company but simply because demand was far greater than the supply and waited for the next IPO to make another killing.

As profit booking became so simple, money flowed from all directions, some legal and some not so legal - the markets boomed and promoters, brokers and investors all made merry. "Entrepreneurs" of all sorts mushroomed to float companies with fancy projects and launched IPOs with tall promises to give high earnings and dividends. But no one bothered to check the prospectuses or the credentials of these promoters because there was enough money to be made by every one or so they thought, until the markets crashed like the proverbial nine pins 

What drove the primary markets to these dizzy heights only to collapse later? Those were the early days of liberalization and the foreign institutional investors and mutual funds had no clue as to the levels of transparency or corporate governance absent in the Indian companies. They believed in the picture specially painted for them by the wily promoters, liked it and invested heavily believing in what was right in the West would be right in the East as well. They were rudely shaken when the promised projects failed to take off because of rampant diversion of money, plain incompetence and severe change in the economic climate.

Then came, the ice winter of stock market gloom, which lasted for probably the longest period in the near history. As investors lost money and faith in the primary market, they punished all the issuers - IPO after IPO failed to get the desired response from the markets - it almost became impossible for any company to raise money from the stock markets. Genuine companies, which lined up on-going projects for funds to be raised from the market were driven to desperation and borrowed at usurious rates that broke the back of their balance sheets. The high cost of borrowing made debt servicing difficult and defaults occurred even from corporate organizations known for their high credit worthiness.

The South Asian crisis further made life very difficult for Indian entrepreneurs as their exports failed to take off and money got locked up in huge inventories. This was the perfect recipe for disaster and doomsayers were busy writing the epitaph on the Indian economic revival. As the economy teetered on the verge of collapse, the outlook has changed slowly but surely - software sector came to the rescue of the markets, a few robust companies lifted the market from their lowest depths to the present peaks of unprecedented highs.

Please refer to the link below - CBSE Class 11 Financial Markets-Primary market