Primary Market Functions, Advantages, Disadvantages, Nature

Table of Contents:-

  • Functions of Primary Market
  • Advantages of Primary Market
  • Disadvantages of Primary Market
  • Meaning of Primary Market
  • Nature of Primary Market

Functions of Primary Market

The main functions of primary market are as follows:

1) Origination

Origination involves the inception of a new issue. The proposal undergoes analysis considering factors such as the nature of the security, the size of the issue, the timing, and the flotation method. Origination is the important phase that precedes the market launch of an issue. It serves as the initial step in establishing the foundation for evaluating the investment climate and obtaining a public subscription for the issue if it is offered. Key factors for careful analysis include the soundness of the project, which pertains to its technical feasibility supported by economic and financial viability. Additionally, it addresses background factors contributing to the success of an issue.

The underlying conditions are:

i) Time of Floating of an Issue: This influences the mood of the investment market. Timing is important as it directly impacts the subscription of an issue.

ii) Type of Issue: This pertains to the type of securities to be issued, whether equity, preference shares, debentures, or convertible securities. These hold significance about the current trends in the investment market.

iii) Price: The public’s inclination towards a specific issue will significantly depend on the pricing of the issue. Well-established firms with group connections may be able to sell their shares at a premium during a new issue, but relatively unknown firms should exercise caution regarding the pricing. The price of shares of these firms should be fixed at par. There is a risk associated with setting prices at a discounted rate, as this practice may result in undervaluing the company and negatively impacting its reputation.

2) Distribution

The third function is the distribution of shares, involving the sale of shares and debentures to investors. This is carried out by brokers and agents who maintain regular lists of clients and directly contact them for the purchase and sale of securities.

3) Underwriting

Underwriting is a type of guarantee undertaken by an institution or a firm of brokers to ensure the marketability of an issue.

Advantages of Primary Market

Investing in the primary market has its benefits, some of the key advantages are:

1) Safety

Manipulation of price is smaller so investing in the primary market is safer.

2) Fund Raising

The company can successfully raise funds through the primary market, which serves as the primary function of the new issue. Therefore, it plays a major role in supporting the growth of the industry and commerce within the country.

3) Platform for New and Existing Companies

It provides a platform for a company to modernize or diversify its business. Both new companies and existing ones have the opportunity to raise capital through the new issue market. It facilitates the transfer of funds from the willing investors to the entrepreneurs setting up new corporate enterprises or going in for expansion, diversification, growth or modernization.

4) Taxes and Brokerage

There is no need to pay any brokerage or transaction fees or any tax such as service tax, stamp duty, and security transaction tax (STT) in the primary market.

5) Good Returns

The investors get a good opportunity to invest in the business and get good returns in the form of interest and dividends.

6) Long-Term Requirement

The companies can get the capital easily for the long term through primary or new issue markets.

7) Setting up of New Business

Primary issues are used by companies to set up new businesses or to expand or modernise the existing business.

8) Attract Small Investors

Small investors have the opportunity to actively engage in the market and purchase securities.

9) Capital Formation

The primary market plays a major role in facilitating capital formation within the economy. Primary market is an important part of the economy of a country. It plays an important role in the growth of both commerce and industry within a country, ultimately exerting an effective impact on its economy.

10) Business Expansions

When a company seeks to secure funds for expanding its operations or establishing a new business venture, it must either obtain a loan from a financial institution or issue shares through the primary market. The primary market is the primary source for any company to raise funds for business expansions.

Disadvantages of Primary Market

The disadvantages of primary market are as follows:

1) Sagging Demand for Funds

The sharp reduction in the demand for funds from the industrial sector is also responsible for the poor show put up by the NIM. This was reflected in the steady decline in the number of issues coming to the market.

2) Overall Economic Slackness

The general retardation in the rate of growth of the economy in the later part of the nineties contributed to the slackness in the new issues market. The economic downturn is mainly due to a slowdown in industrial growth.

3) Eroded Investor Confidence

There was a lack of enthusiasm shown by the investors for new issues, especially the small investors. Furthermore, there has been a significant decline in investor confidence due to the substantial losses they have incurred in the recent past. With the globalization of stock markets greater research on equity and the advent of Flls, investors are becoming better informed and are not willing to pay unreasonably high prices for new issues.

4) Depressed Capital Market

The depressed capital market conditions are, to a large extent, attributable to the general slowdown in the economy. This has had a major impact on the Net Interest Margin (NIM).

5) Inadequate Disclosures

The corporates were not showing much interest in making adequate disclosure of information that is needed by the investors to assess the nature of projects for which funds are sought to be raised by them. Many corporations are exhibiting a conspicuous disinterest in adopting the principles of sound corporate governance. This has deeply eroded the confidence of investors.

Compared to corporates in the developed capital markets, Indian companies still do not make adequately transparent and truthful disclosures to either the investors or to stock exchanges. There have been cases where companies have diverted funds for purposes other than those outlined in the offer documents. Unless the companies dispel the fears in the minds of investors through transparent disclosures, the investors will remain wary of returning to the primary market at full strength.

6) Lack of Liquidity

Movement in the primary market is also closely related to the secondary market. Except for a few securities, the secondary market lacked depth, resulting in investors being trapped for excessively long periods. Market participants faced a powerful challenge due to the absence of liquidity. The following factors afflict the growth of the secondary market and thus cause illiquidity:

i) As stock lending has not gained popularity, short selling is also not possible for them.

ii) Unpopularity of market-marking and bank credit to market makers being restricted.

iii) Market turnover is often driven not by fundamentals such as EPS, growth, etc., but by speculation.

7) Private Placements

Companies are increasingly opting for private placement routes for certain obvious advantages like lower transaction costs, limited disclosure requirements in the offer documents and mobilisation of funds in a shorter timeframe. This tool led to the unpopularity of the Net Interest Margin (NIM).

8) Business Re-Structuring

The liberalisation that was set in motion since the beginning of the nineties has been responsible for causing a massive jump in mergers and amalgamation. This has brought about the trends of restructuring and consolidation after the initial phase of expansion following the introduction of measures of reform. This is evident from the growing number of cases of demergers, stripping of business lines or a product line or divisions, concentrating on areas of core competence, formation of joint venture and strategic alliances, large mergers and amalgamations in the face of takeover threats, etc. Due to increasing competition and the expanding global integration of the economy, the necessity for this measure has arisen. All these developments have resulted only in business re-structuring and expansion.

Meaning of Primary Market

The primary market, also referred to as the New Issue Market (NIM), is the initial platform where newly issued securities, such as shares or bonds, are made available for the first time. This market exclusively deals with securities that have never been issued before. Both existing and new companies can raise capital in the new issue market. The major function of the new issue market is to facilitate the transfer of funds from willing investors to entrepreneurs who are establishing new corporate enterprises or pursuing diversification, expansion, growth, or modernization.

Besides, helping corporate enterprises in securing their funds, the new issue market channelises the savings of individuals and others into investments.

The issuing companies and the investors represent the two fundamental aspects of this market, namely, demand and supply, respectively. However, the organization of the new issue market is incomplete without the intermediaries institutions, specialized agencies, etc. These entities play an important role in promoting issues of new securities and help in selling, transferring, underwriting etc. These agencies include a wide range of entities, such as underwriters, financial institutions, brokers, merchant bankers, and so on.

The new issue market plays a major role in channelling savings toward long-term investments, thereby exerting a deep impact on a country’s economic growth and industrial development. The availability of financial resources for corporate enterprises greatly depends on the status of the new issue market in the country.

Nature of Primary Market

The nature of primary market is as follows:

1) The New Issue Market (NIM) is another name for primary market.

2) The main objective of the market is to obtain new long-term capital.

3) Security certificates are issued to investors.

4) Securities are sold for the first time in this market.

5) Securities are issued by companies for setting up new businesses and for expanding or modernizing existing businesses.

6) Securities are issued directly to investors.

7) Funds generated in this market are utilized for the purchase of fixed assets.

8) It is the process of going public, i.e., converting private capital into public capital.

9) It facilitates capital formation in the economy.

10) It does not include long-term loans from financial institutions.

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