Chapter 2

Security Market
2.1 Concept of Primary Market
In a primary market, securities are created for the first time for investors to purchase. New
securities are issued in this market through a stock exchange, enabling the government as well
as companies to raise capital.
For a transaction taking place in this market, there are three entities involved. It would include
a company, investors, and an underwriter. A company issues security in a primary market as
an initial public offering (IPO), and the sale price of such new issue is determined by a
concerned underwriter, which may or may not be a financial institution. An underwriter also
facilitates and monitors the new issue offering. Investors purchase the newly issued securities
in the primary market. Such a market is regulated by the Securities and Exchange Board of
India (SEBI).
The entity which issues securities may be looking to expand its operations, fund other
business targets or increase its physical presence among others.  Primary market example of
securities issued includes notes, bills, government bonds or corporate bonds as well as stocks
of companies.

2.2 Functions of Primary Market

The functions of such a market are manifold –

 New issue offer

The primary market organizes offer of a new issue which had not been traded on any other
exchange earlier. Due to this reason, it is also called a New Issue Market. Organizing new
issue offers involves a detailed assessment of project viability, among other factors. The
financial arrangements for the purpose include considerations of promoters’ equity,  liquidity
ratio, debt-equity ratio and requirement of foreign exchange.
 Underwriting services
Underwriting is an essential aspect while offering a new issue. An underwriter’s role in a
primary marketplace includes purchasing unsold shares if it cannot manage to sell the
required number of shares to the public. A financial institution may act as an underwriter,
earning a commission on underwriting. Investors rely on underwriters for determining
whether undertaking the risk would be worth its returns. It may so thus happen that an
underwriter ends up buying all the IPO issue, and subsequently selling it to investors.
 Distribution of new issue
A new issue is also distributed in a primary marketing sphere. Such distribution is initiated
with a new prospectus issue. It invites the public at large to buy a new issue and provides
detailed information on the company, issue, and involved underwriters.

2.3 Types of Primary Market Issuance

After the issuance of securities, investors can purchase such securities in various ways. There
are 5 types of primary market issues.

 Public issue
Public issue is the most common method of issuing securities of a company to the public at
large. It is mainly done via Initial Public Offering (IPO) resulting in companies raising funds
from the capital market. These securities are listed in the stock exchanges for trading.

A privately held company converts into a publicly-traded company when its shares are offered
to the public initially through IPO. Such public offer allows a company to raise funds for
expansion of business, improving infrastructure, and repay its debts, among others. Trading in
an open market also increases a company’s liquidity and provides a scope for issuance of
more shares in raising further capital for business.

The Securities and Exchange Board of India is the regulatory body that monitors IPO. As per
its guidelines, a requisite due enquiry is conducted for a company’s authenticity, and the
company is required to mention its necessary details in the prospectus for a public issue.

 Private placement
When a company offers its securities to a small group of investors, it is called private
placement. Such securities may be bonds, stocks or other securities, and the investors can be
both individual and institutional.
Private placements are easier to issue than initial public offerings as the regulatory
stipulations are significantly less. It also incurs reduced cost and time, and the company can
remain private. Such issuance is suitable for start-ups or companies which are in their early
stages. The company may place this issuance to an investment bank or a hedge fund or place
before ultra-high net worth individuals (HNIs) to raise capital.

 Preferential issue
A preferential issue is one of the quickest methods available to companies for raising capital.
Both listed and unlisted companies can issue shares or convertible securities to a select group
of investors. However, the preferential issue is neither a public issue nor a rights issue. The
shareholders in possession of preference shares stand to receive the dividend before the
ordinary shareholders are paid.

 Qualified institutional placement

Qualified institutional placement is another kind of private placement where a listed company
issues securities in the form of equity shares or partly or wholly convertible debentures apart
from such warrants convertible to equity shares and purchased by a Qualified Institutional
Buyer (QIB).

QIBs are primarily such investors who have the requisite financial knowledge and expertise to
invest in the capital market. Some QIBs are –

 Foreign Institutional Investors registered with the Securities and Exchange Board of
India.
 Foreign Venture Capital Investors.
 Alternate Investment Funds.
 Mutual Funds.
 Public Financial Institutions.
 Insurers.
 Scheduled Commercial Banks.
 Pension Funds.
Issuance of qualified institutional placement is simpler than preferential allotment as the
former does not attract standard procedural regulations like submitting pre-issue filings to
SEBI. The process thus becomes much easier and less time-consuming.

 Rights and bonus issues

Another issuance in the primary market is rights and bonus issue, in which the company
issues securities to existing investors by offering them to purchase more securities at a
predetermined price (in case of rights issue) or avail allotment of additional free shares (in
case of bonus issue).

For rights issues, investors retain the choice of buying stocks at discounted prices within a
stipulated period. Rights issue enhances control of existing shareholders of the company, and
also there are no costs involved in the issuance of these kinds of shares. For bonus issues,
stocks are issued by a company as a gift to its existing shareholders. However, the issuance of
bonus shares does not infuse fresh capital.
2.4 Meaning of Secondary Market
In simple terms, the secondary market is described as a financial market where the securities that
are already owned by an investor are bought and sold. Several other names like popularly know
the secondary market

 Stock market
 Aftermarket
 Follow on public offering

One of the most popularly traded securities is stocks, and besides these, you will find other types
of secondary markets as well. Investment banks, as well as individual and corporate investors,
can deal in buying and selling of bonds and mutual funds.

Examples of secondary market

Prime examples are national exchanges like NSE (National Stock Exchange), LSE (London
Stock Exchange), NASDAQ, and NYSE (New York Stock Exchange).

If an investor wants to buy shares of a company, he will have to do so from a secondary market

similarly when he wants to sell then he will have to do so again in a secondary market.

For the general investor, it is an efficient marketplace for trading securities, and for a company, it
is a monitoring and controlling channel.

Examples of secondary market

Prime examples are national exchanges like NSE (National Stock Exchange), LSE (London
Stock Exchange), NASDAQ, and NYSE (New York Stock Exchange).

If an investor wants to buy shares of a company, he will have to do so from a secondary market

similarly when he wants to sell then he will have to do so again in a secondary market.

2.5 Functions of Secondary Market

 A stock exchange provides a platform to investors to enter into a trading transaction of
bonds, shares, debentures and such other financial instruments.
 Transactions can be entered into at any time, and the market allows for active trading
so that there can be immediate purchase or selling with little variation in price among
 different transactions. Also, there is continuity in trading, which increases the liquidity of
assets that are traded in this market.

 Investors find a proper platform, such as an organized exchange to liquidate the

holdings. The securities that they hold can be sold in various stock exchanges.

 A secondary market acts as a medium of determining the pricing of assets in a

transaction consistent with the demand and supply. The information about transactions
price is within the public domain that enables investors to decide accordingly.

 It is indicative of a nation’s economy as well, and also serves as a link between

savings and investment. As in, savings are mobilized via investments by way of securities.

2.6 Types of secondary market

There are two types of the secondary market which have been described below-

1. OTC or Over-The-Counter Markets

An OTC market is considered a decentralized place where the members trade amongst
themselves. The competition to get higher volumes is fierce; hence, the price of securities differs
from one to another seller.

The interested parties deal on a one-to-one basis with each other, so the counterparty risk is
much higher if compared with Exchanges. Example of the OTC market is FOREX or Foreign
Exchange Market.

2. Exchanges

In this marketplace, you will not find any direct contact between the two main parties, the seller
and the buyer. Heavy regulations are in place to make it a safe zone for trading securities. The
exchange in itself is a guarantor, and the probability for counterparty risk is almost zero.

The transaction cost is a bit high because of the commission and exchange fees. Examples of
Exchanges are the New York Stock Exchange (NSE) and the London Stock Exchange (LSE).
The secondary market can be further divided into

1. Auction market
It is a platform where both the seller and buyer meet and then announce the rate at which they
are willing to trade their securities. Everything is announced publicly, and that includes the
offeror bidding price.

2. Dealer market

In this type of secondary market, the transactions happen through an electronic network like
telephones and fax machines.

2.7 Advantages of secondary market

The advantages are as follows-

1. Secondary markets offer a chance to the investor to save as well as invest and thus earn
some returns.
2. It offers an opportunity for quick and good gains in a shorter time frame
3. Investment does not require a huge amount hence it is possible to do so with a small
amount of money
4. The stock prices in the secondary market help to value a company effectively
5. It is an apt indicator of the economic condition of a company as the dropping or rising
prices suggest a recession or a boom, respectively in the economy.
6. A firm can monitor as well as control public perceptions through its activities in the
secondary market
7. It is easy to sell or buy securities hence ensures liquidity for an investor
8. When money is held in the form of shares, the mobilization of savings becomes easier.
9. Investing in the shares of a company gives you the feeling of ownership even if it is a
minority and very small
10. Besides being an investment platform, the secondary market also offers investment
advice on complex matters. There are key players for this role, for example, investment
advisors and stockbrokers.
11. In several companies, even minority ownership allows the investor to vote and voice your
opinion at the general meeting
12. The shareholders are the owners of a company whose shares are traded in a secondary
market. It tends to improve corporate governance as the managers have to be accountable
for every action in front of the shareholders.
2.8 Disadvantages of Secondary Market
1. The disadvantages are as price fluctuates in secondary markets, and the volatility of the
unpredictable market can result in a quick and sudden loss
2. It’s a time-consuming process as an investor has to complete certain formalities before he
can buy or sell in secondary markets
3. Sometimes government policies act as a hindrance and misguide the market situations.
This results in great upheavals, and it is the companies that have to bear the loss and
damage.
4. The risk is greater as the market is influenced by various external forces that can result in
an upward or downward trend within minutes
5. An investor has to pay a brokerage commission every time he decides to buy or sell the
shares. It simply lessens the profit margin

2.9 Different Types of Stock Orders in Secondary Market

While some investors choose to work with a financial advisor who invests on their behalf, others
choose to take a DIY approach, buying and selling their own stocks. As you know if you’ve ever
tried to buy stock, though, there are different varieties of stock orders. Some orders execute
immediately; some execute only at a specific time, or price; and others have additional
conditions attached. What kind of order you use can make a big difference in the price you pay
and the returns you earn, so it’s important to be familiar with the different types of stock orders?

Market Order
A market order is when an investor requests an immediate execution of the purchase or sale of a
security. While this type of order guarantees the execution of the order, it doesn’t guarantee the
execution price. Generally, it will execute at (or close to) the current bid (sell) or ask (buy) price.
Investors can provide either simple or complex market order instructions, which brokers or
trading market venues can access.

When executing a market order, investors don’t have control over the final price. The execution
of the stock order correlates to the availability of buyers and sellers. Depending on the pace of
the market, the price paid or sold may drastically vary from the price quoted.

It’s also possible to split market orders. Splitting market orders may result in multiple price
points, caused by several investors’ participation in the transaction. Since most market orders are
typically simple, online and traditional brokers may receive a minimal commission.
Limit Order

If you’re looking to execute an order at a specific price, you’ll want to complete a limit order.
With a limit order you determine a certain price you want to purchase or sell a security for. The
order is only executes when you have a buyer or seller that will pay or sell a security for that
price.

A buy limit order only executes at the limit price or below. For example, if an investor would
like to purchase Apple Inc. for no more than $195 per share, the investor would place a limit
order. Once the share price reaches $195, the order executes. While a sell limit is similar, it’s
only executed when the stock reaches the limit price or exceeds it.

Time in Force

If you want to indicate how long an order will stay active, you’ll want to use a time in force
order. For example, day order or good for day orders (GFD) are orders where the investor would
like to buy or sell a security during a certain timeframe. Once the investor requests the order, it
will expire after a specified time during the day. These orders are only valid during the day
they’re requested in. If time in force orders are not executed during the day, they’re canceled at
the end of the trading day.

Investors can also request good-til-canceled (GTC) which requires certain cancelation criteria
continue indefinitely. Another request option is an immediate or cancel order (IOC) which
executes or cancels the order instantly.

Market-if-Touched Order

A buy market-if-touched order is an order that requests a buy at the best available price, or the 
“if touched” level. If the security price drops to this level, the order becomes a market purchase
order. Whereas with a sell market-if-touched order, the sale occurs when a buyer wants to pay
the “if touched” level.

One Cancels Other Orders

Investors can use a one cancels other order when they want to capitalize on one of two trading
options. For instance, if an investor wishes to trade ABC stock at $100 per share or XYZ stock at
$50 per share, the one who reaches the designated price first will be the one that occurs. So, if
ABC stock reaches $100 per share, the order is then executed and the order for XYZ stock is
canceled.
One Sends Other Order

One sends other order is when an investor wishes to send another order once their previous order
is complete. For example, if a trader wants to buy ABC stock for $100 per share and then what’s
to turn it around and make a profit, they would need to complete a two part order. The first part
is a limit order for the purchase of ABC stock at $100 per share. The second part would be to sell
ABC stock at $105 per share. Multiple orders go into the system simultaneously and are then
execute in a sequential manner.

At The Opening Order

If an order lists the contingency at the opening, then the order must be one of the first trades of
the day. If the order doesn’t execute right away, after the opening bell, then the order will not
move forward.

2.10 What is Short Selling?

Short selling is a trading strategy that seeks to capitalize on an anticipated decline in the price of
a security. Essentially, a short seller is trying to sell high and buy low.

2.10.1 How does Short Selling work?

Short selling involves a three-step process.

1) Borrow shares of the security, typically from a broker.
2) Sell the shares immediately at the market price.
3) Repurchase the shares (hopefully at a lower price) and return them to whoever you borrowed
them from. After all this, you will pocket the difference if the share price has fallen, but will
have lost money if the price went up.
We'll illustrate the process with an example:
Mr. Johnson believes that the stock of ABC Corp. will fall in the future. He calls his broker and
asks him to find 100 shares of ABC that he (Mr. Johnson) can borrow for a short sale. ABC's
current price is $25 per share. Mr. Johnson receives a cash inflow of $2,500 after he sells the
shares he has borrowed.
Two weeks later, the price has indeed dropped, and shares of ABC now trade for $20 each.  Mr.
Johnson buys back the shares (known as covering his short position) for $20 each. He spends
$2,000 to repurchase the shares and returns the shares to the person he borrowed them from.
Mr. Johnson's profit on the trade is $500 ($2,500 received from the sale of the stock minus
$2,000 paid to repurchase the stock).
Using this same calculation, we see that if the shares had risen to $27 during his holding period,
then he would have lost $200 ($2,500 received from the sale of the stock minus $2,700 paid to
repurchase the stock).

2.10.2 Why does Short Selling is risky?

Short selling is risky for a number of reasons. First, an investor is exposed to theoretically
unlimited losses if the underlying stock rises instead of falls.
Second, a sharp rise in a particular stock can trigger a large number of short sellers to cover their
positions all at once. Short covering can push share prices even higher, causing even more short
sellers to cover their positions, and so on. In this case, the stock is caught in a "short squeeze."
Volatile stocks with large short interest are particularly susceptible to this phenomenon, and
prospective short sellers should be wary of it.
An investor can quickly determine the percentage of a company's outstanding shares that are
currently being sold short by checking the stock's "short interest." For example, a 10% short
interest means that one of every ten outstanding shares is held short.