Primary market

There are only two ways to buy a share, and the difference decides who gets your money.

In the primary market you buy the security from the issuer. The company is creating that share or bond at that moment, and your rupees land in the company's bank account, to build a factory or repay a loan.

In the secondary market you buy from another investor. The share already exists; your rupees go to the person selling it. The company receives nothing and its capital does not change.

That is the whole distinction, and almost every exam question on this chapter turns on it. The primary market is also called the "new issue market", and the act of a company opening itself to outside investors for the first time is called going public.

An issuer cannot simply announce a sale of shares. It must work through a merchant banker, who judges whether the business is ready to raise capital, structures the instrument, helps price it, identifies the investors and runs the whole mobilisation. One of the merchant bankers is designated the Book Running Lead Manager, who carries due diligence, the prospectus and compliance with SEBI.

Around that sit the rest of the machinery: registrar and transfer agents recording applications, bankers to the issue handling money, brokers procuring subscription, underwriters committing to take up whatever the public does not, and depositories to credit the shares in electronic form.

Who regulates the issue depends on what is being issued. SEBI regulates the primary market for equity shares, for corporate bonds, and for depository receipts. The RBI regulates the primary market for government securities, issuing them to banks and primary dealers by auction against a published borrowing calendar.

The workbook lists seven functions the primary market performs: it taps a larger pool of capital, forces a competitive price-discovery process, diversifies ownership (which separates ownership from management and improves governance), compels better disclosure, subjects the issuer to evaluation by thousands of investors and analysts, gives early investors an exit, and creates liquidity by making listing mandatory for a public issue.

Issuance falls under four heads: public issue (open to anyone eligible), private placement (a select set of institutional investors), preferential issue (an identified group on preferential terms) and rights and bonus issues (to existing shareholders as on a record date).

A logistics company goes public. The issue is Rs 600 crore, priced at Rs 250 a share, and is structured in two parts:

Both halves are primary market activity — both are the first sale of those securities to public investors. But only the Rs 400 crore fresh issue adds to the company's share capital and lands in its account. The Rs 200 crore offer for sale is the promoter cashing out; the company's balance sheet does not move by a rupee.

The issue lists a week later and opens at Rs 310. On day one, 90 lakh shares change hands — roughly Rs 279 crore of turnover. The company receives nothing from any of it. That is the secondary market doing its job: providing liquidity to the people who subscribed, and a price signal that will be used to price the next company's issue.

The direction of that dependence is worth remembering. In a bull market, primary issues are more numerous and priced more favourably to issuers; in a bear market, getting a new issue adequately subscribed is hard work.

Chapter 3 (Primary Markets) opens with exactly this definition and devotes section 3.2 to "Primary Vs Secondary Markets". It is the highest-yielding definitional pair in the paper. Expect: a direct question on who receives the proceeds; a question on which of four described transactions is a primary market activity; a list-match on the functions of the primary market; and a regulator question — SEBI for equity and corporate debt, RBI for government securities. Chapter 3 also supplies the four-way classification of issues, which is a favourite multiple-choice frame.

• Primary does not mean "public". A private placement to twelve institutions, and the very first issue of shares to promoters when a company is set up, are both primary market activity. Public versus private is a different axis from primary versus secondary.
• An Offer for Sale is primary market activity, but it raises nothing for the company. The shares already existed; a shareholder is selling them. Only the fresh issue portion increases share capital.
• Two regulators, not one. Government securities are issued by the RBI by auction; everything else public in the primary market is SEBI's.
• Listing is mandatory for a public issue — that is how the primary market creates secondary market liquidity. A private placement carries no such automatic consequence.
• The secondary market price does not change the issuer's capital. A share that doubles on listing has not given the company one extra rupee. It has only made the next issue easier to price.
• Do not confuse the merchant banker with the underwriter. The merchant banker manages the issue; underwriting is a separate commitment to subscribe to whatever is left unsubscribed, for a commission — and merchant bankers often do both.