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Primary Market and Book building process

1. Instruments in the Primary Market

The primary market issues various financial instruments to raise capital. These can be broadly classified into equity, debt, and hybrid securities.

A. Equity Instruments
  1. Initial Public Offering (IPO):
    • Definition: The first time a company offers its shares to the public to raise capital.
    • Outcome: Investors become shareholders and gain ownership in the company.
    • Pricing: Can be through fixed-price or book-building methods.
  2. Follow-on Public Offering (FPO):
    • Definition: Additional shares issued by a company that is already publicly listed.
  3. Rights Issue:
    • Definition: Existing shareholders are offered additional shares at a discounted price, in proportion to their current holdings.
  4. Private Placement:
    • Definition: Securities are sold directly to institutional investors rather than the general public.
    • Example: Qualified Institutional Placement (QIP) for raising funds from Foreign Institutional Investors (FIIs).
B. Debt Instruments
  1. Corporate Bonds/Debentures:
    • Definition: Companies issue bonds to raise long-term funds with fixed interest payments (coupon).
  2. Government Securities (G-Secs):
    • Definition: The government raises funds by issuing treasury bills, bonds, or sovereign gold bonds.
  3. Commercial Papers (CPs):
    • Definition: Short-term unsecured debt issued by corporations to meet working capital needs.
  4. Certificate of Deposits (CDs):
    • Definition: Time deposits issued by banks with a fixed maturity period.
C. Hybrid Instruments
  1. Convertible Debentures:
    • Definition: A mix of equity and debt, allowing conversion into equity shares at a later date.
  2. Preference Shares:
    • Definition: Shareholders receive fixed dividends before common shareholders but have limited voting rights.

2. Book Building Process in the Primary Market

Book building is a price discovery mechanism used during an IPO or FPO, where investors bid for shares at different price levels within a specified range. The final issue price is determined based on demand.

Steps in the Book Building Process
  1. Appointing Underwriters and Merchant Bankers:
    • The company hires an investment bank to manage the issue.
    • The lead manager files a Draft Red Herring Prospectus (DRHP) with SEBI.
  2. Price Band Announcement:
    • The issuer announces a floor price (minimum) and a cap price (maximum) for bids.
    • Example: If a company sets a price band of ₹100-120, investors can bid within this range.
  3. Bidding Process:
    • Investors submit bids, mentioning the number of shares and the price they are willing to pay.
  4. Determining the Cut-off Price:
    • The cut-off price is decided based on demand (highest subscription level).
    • Investors who bid below this price do not get shares.
  5. Allotment of Shares:
    • Shares are allotted to investors who bid at or above the cut-off price.
    • The final price is determined based on the weighted average of successful bids.
  6. Listing on Stock Exchange:
    • After allotment, shares are listed on NSE/BSE for secondary market trading.
Advantages of the Book Building Process:
  • Market-Driven Pricing: Prevents overpricing or underpricing of shares.
  • Transparency: Demand-based price discovery ensures fairness.
  • Efficient Allocation: Ensures shares go to those who value them the most.
  • Better Investment Decision: Investors can assess demand before subscribing.

Conclusion

The primary market is crucial for capital formation in the economy, providing businesses with long-term financing. Book building has largely replaced fixed-price issues due to its efficient, transparent, and demand-driven pricing mechanism. It facilitates better price discovery and allocation of shares, benefiting both issuers and investors.

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