Valuation and Pricing

Ammar Hafeez
 Primary market
vs
Secondary market
How do new securities get floated
for the first time?
 1.Initial Public Offer (IPO)
• In this method, a firm issues a prospectus to the public,
inviting offers to subscribe for their securities.
• The investors who are interested, apply for the securities in
the requisite quantity.
• Usually, advertisements are issued in leading newspapers.
• Under the Companies Act 2013, it is obligatory for a public
limited company to issue a ‘prospectus’ or file ‘a statement
in lieu of prospectus’ with the Registrar of Companies.
The prospectus must be drafted and issued in accordance
with the provisions of the Companies Act and the
guidelines of SEBI.
• Once subscriptions are received, the firm allots
securities keeping in view the prescribed requirements.

Advantages and Disadvantages

• Public issue or direct selling of securities is the most
common method of selling new issues of securities.
• This method enables a company to raise funds from a
large number of investors widely scattered throughout
the country.
• This method ensures a wider distribution of securities
thereby leading to diffusion of ownership and avoids
concentration of economic power in a few hands.
• However, this method is quite cumbersome involving a
large number of administrative problems.
• It also does not guarantee the raising of adequate
funds unless the issue is underwritten.

• In short, this method is suitable for reputed firms

which want to raise large capital and can bear the large
costs of a public issue.
 2.Private placement
• In this method, the firm sells its securities privately to
one or more institutional brokers who in turn sells
them to their clients and associates.

Advantages and Disadvantages

• This method is quite convenient and economical.
Moreover, the company gets the money quickly and
there is no risk of non-receipt of minimum
subscription.
• Private placement, however suffers from certain
drawbacks. The financial institution may insist on a
huge discount or other conditions for private purchase
of securities.
• Secondly, it may not sell the securities in the market
but keep with it with them. This deprives the public a
chance to purchase securities of a flourishing company
and there may be concentration of the firm’s
ownership in a few hands.

Private placement is very much suitable for small

issues particularly during the period of depression.
 3.Offer for sale
• In this method, the issuing firm allots or agrees to allot its
securities to an issue house or a financial institution at an agreed
price.
• The issue house publishes a document called an ‘offer for sale’. It
offers to the public shares or debentures for sale at higher price.
• Application form is attached to the offer document. After
receiving applications, the issue house renounces the allotment
in favor of the applicants who become direct allottees of these
securities.

Advantages and Disadvantages

• This method saves the firm from the cost and trouble of selling
securities directly to the investing public.
• It ensures that the whole issue is sold and stamp duty
payable on transfer of shares is saved.
• However, one major negative is that the entire
premium received is retained by the offerer and not
the issuing firm.
 4. Sale through intermediaries
• In this approach, a firm appoints intermediaries like
stock brokers, commercial banks and financial
institutions to assist in finding market for the new
securities on a commission basis.
• The firm supplies blank application forms to each
intermediary who affixes his seal on them and
distributes it among prospective investors.
• Each intermediary gets commission on the amount of
security applications bearing his seal.
• However, intermediaries do not guarantee the sale of
securities.
Advantages and Disadvantages
• This method saves the administrative problems and
expenses involved in direct selling of securities to the
public.
• The pace of sale of securities may be very slow and
there is uncertainty about the sale of whole lot of
securities offered through intermediaries.

Because of its time taking nature and uncertainty, this

method is useful when a firm has already offered 49
per cent of issue to the general public which is
essential for listing of securities.
 5.Privileged subscription/Rights issue
• In scenarios of firms wanting to issue further securities, one
of the approaches is privileged subscription.
• Firms following this approach are required to offer the
securities to existing shareholders on a pro-rata basis. This is
known as ‘Rights Issue’.

Advantages and Disadvantages

• Sale of shares by rights issues is simpler and cheaper as
compared to sale through prospectus.
• One major drawback is that the existing shareholders will
only subscribe to the new issues, if the past performance
and future prospects of the firm are good.
 6.Book building
• It is a process through which firms determine the
demand and the price of a proposed issue of securities
through public bidding.
• A firm either offers its securities to the public at fixed
price or offers a price range. By following the latter, the
investors get an opportunity to ‘discover’ price for the
securities which are on offer.

Book building process :

1. The issuing firm hires an investment bank to act
as an underwriter. The underwriter is tasked with
determining the price range, the security can be sold
 for. The underwriter is also responsible for drafting
a prospectus which is shared with the institutional
investing community.
2. Large scale buyers and fund managers submit bids
during the period when the offer remains open. They
provide the number of shares that they are interested
to buy and the prices that they would be willing to pay.
3. The book is 'built' by listing and evaluating the
aggregated demand for the issue from the submitted
bids.
4. The underwriter after analyzing the information, uses a
weighted average to arrive at the final price for the
security, which is termed the 'cut off' price.
5. At that price, the securities are allocated to the
accepted bidders.

• The underwriter has to, for the sake of transparency,

publicize the details of all the bids that were
submitted.

Advantages and disadvantages

• Even if the information collected during the book
building suggests a particular price point is best, that
does not guarantee a large number of actual purchases
once the IPO is open to buyers.
 How do the already floated
securities, get transacted in the
secondary market?
The secondary market is where the investors buy and
sell securities they already own. 

Any transactions in the secondary market occur

between investors, and the proceeds of each sale go
to the selling investor, not to the firm that issued the
security or to the underwriting bank. 

Prices on the secondary market fluctuate and may be

determined by basic forces of supply and demand. 
 Types of secondary
markets

Commodities Derivatives Forex trading

Stock market Bond market
market market market