An IPO is an initial public offering.

In an IPO, a privately owned company lists its shares on a stock

Many people think of IPOs as big money-making opportunities—high-profile companies grab headlines
with huge share price gains when they go public. But while they’re undeniably trendy, you need to
understand that IPOs are very risky investments, delivering inconsistent returns over the longer term.

How Does an IPO Work?

Going public is a challenging, time-consuming process that’s difficult for most companies to navigate
alone. A private company planning an IPO needs not only to prepare itself for an exponential increase in
public scrutiny, but it also has to file a ton of paperwork and financial disclosures to meet the
requirements of the Securities and Exchange Commission (SEC), which oversees public companies.

That’s why a private company that plans to go public hires an underwriter, usually an investment bank,
to consult on the IPO and help it set an initial price for the offering. Underwriters help management
prepare for an IPO, creating key documents for investors and scheduling meetings with potential
investors, called roadshows.

“The underwriter puts together a syndicate of investment banking firms to ensure widespread
distribution of the new IPO shares,” says Robert R. Johnson, Ph.D., chartered financial analyst (CFA) and
professor of finance at the Heider College of Business at Creighton University. “Each investment banking
firm in the syndicate will be responsible for distributing a portion of the shares.”

Once the company and its advisors have set an initial price for the IPO, the underwriter issues shares to
investors and the company’s stock begins trading on a public stock exchange, like the New York Stock
Exchange (NYSE) or the Nasdaq.

Why Do an IPO?

An IPO may be the first time the general public can buy shares in a company, but it’s important to
understand that one of the purposes of an initial public offering is to let early investors in the company
cash out their investments.
Think of an IPO as the end of one stage in a company’s life-cycle and the beginning of another—many of
the original investors want to sell their stakes in a new venture or a start-up. Alternatively, investors in
more established private companies that are going public also may want the opportunity to sell some or
all of their shares

“The reality is that there’s a friends and family round, and there are some angel investors who came in
first,” says Matt Chancey, a certified financial planner (CFP) in Tampa, Fla. “There’s a lot of private
money—like Shark Tank-type money—that goes into a company before ultimately those companies go
public.”

There are other reasons for a company to pursue an IPO, such as raising capital or boosting a company’s
public profile:

Companies can raise additional capital by selling shares to the public. The proceeds may be used to
expand the business, fund research and development or pay off debt.

Other avenues for raising capital, via venture capitalists, private investors or bank loans, may be too
expensive.

Going public in an IPO can provide companies with a huge amount of publicity.

Companies may want the standing and gravitas that often come with being a public company, which
may also help them secure better terms from lenders.

While going public might make it easier or cheaper for a company to raise capital, it complicates plenty
of other matters. There are disclosure requirements, such as filing quarterly and annual financial
reports. They must answer to shareholders, and there are reporting requirements for things like stock
trading by senior executives or other moves, like selling assets or considering acquisitions.

Key IPO Terms

Like everything in the world of investing, initial public offerings have their own special jargon. You’ll
want to understand these key IPO terms:

Common stock. Units of ownership in a public company that typically entitle holders to vote on
company matters and receive company dividends. When going public, a company offers shares of
common stock for sale.
Issue price. The price at which shares of common stock will be sold to investors before an IPO company
begins trading on public exchanges. Commonly referred to as the offering price.

Lot size. The smallest number of shares you can bid for in an IPO. If you want to bid for more shares, you
must bid in multiples of the lot size.

Preliminary prospectus. A document created by the IPO company that discloses information about its
business, strategy, historical financial statements, recent financial results and management. It has red
lettering down the left side of the front cover and is sometimes called the “red herring.”

Price band. The price range in which investors can bid for IPO shares, set by the company and the
underwriter. It’s generally different for each category of investor. For example, qualified institutional
buyers might have a different price band than retail investors like you.

Underwriter. The investment bank that manages the offering for the issuing company. The underwriter
generally determines the issue price, publicizes the IPO and assigns shares to investors.

SPACs and IPOs

Recent years have seen the rise of the special purpose acquisition company (SPAC), otherwise known as
a “blank check company.” A SPAC raises money in an initial public offering with the sole aim of acquiring
other companies.

Many well-known Wall Street investors leverage their established reputations to form SPACs, raise
money and buy companies. But people who invest in a SPAC aren’t always informed which firms the
blank check company intends to buy. Some disclose their intention to go after particular kinds of
companies, while others leave their investors entirely in the dark.

“It’s giving your money to an entity that doesn’t own anything but tells you, ‘Trust me, I’ll only make
good acquisitions with it,’” says George Gagliardi, a CFP in Lexington, Mass. “Like a baseball batter
wearing a blindfold, you don’t know what’s coming at you.”

Many private companies choose to be acquired by SPACs to expedite the process of going public. As
newly formed companies, SPACs don’t have long financial histories to disclose to the SEC. And many
SPAC investors can recoup their money in full if a SPAC does not acquire a company within 24 months.

Upcoming IPOs
IPO activity hit record highs in 2021, thanks to the very strong stock market. The IPO outlook for 2022 is
very different, with expected initial offerings being postponed and even cancelled thanks to the many
issues facing the market. Here are some of the more prominent upcoming IPOs:

Companies typically issue an IPO to raise capital to pay off debts, fund growth initiatives, raise their
public profile, or to allow company insiders to diversify their holdings or create liquidity by selling all or a
portion of their private shares as part of the IPO.

What are the benefits of investing in Equity Shares?

When investing, it is critical to be aware of your risk appetite and consequently, balance the amount of
risk involved in your investments. Equity is an asset class that offers great potential in maximizing
returns. However, you must be willing to take on the required risk which can range anywhere from
moderate to high.

Apart from the inherent risk of investment, multiple factors discourage people from investing in the
stock market. You must study the market consistently and then make such financial decisions.

Experienced and amateur investors have made significant gains with due financial planning and
investing, especially in equity. There are numerous avenues available to you to invest in equities –
Mutual funds, tax-saving equity-linked savings schemes ELSS, or investing directly in stocks. India has
seen a growing interest from investors in equity. So, why is everyone dipping their foot into this risky
affair? There sure are benefits of investing in equity that you should know about.

Ownership

Investing in shares of a company makes you a shareholder or a member of the company. In simple
terms, you get ownership of the company and can exercise control. As an investor, you would enjoy a
share of the income earned by the company. Additionally, you would also get voting rights in the
company.

Higher Returns

The primary advantage of investing in equity is that it can generate high returns in a short time in
comparison to other investment options like Bank FDs. Presently, the equity market is reaching all-time
highs as it recovers from the Covid-19 setback of 2020. With appropriate stock picks and a solid trading
strategy, the stock market can potentially provide you with unparalleled returns going forward.

Dividend
One of the benefits of investing in equity is that it offers returns in not just one, but two forms — capital
appreciation and dividend income. A dividend is a distribution of surplus profits by a company to its
shareholders. Dividend income is essentially an additional income to the investor.

Limited liability

There is always a risk of adversity when it comes to companies such as bankruptcy or operational losses.
However, your liability as a shareholder or investor is restricted to the amount of investment you’ve
made, and not a penny more.

Liquidity

Stocks are generally considered liquid assets. The shares can very easily transfer ownership. The average
daily volume of transactions on NSE and BSE is considerably high. This means several buyers and sellers
are participating in the market at any given point of the day.

Beat inflation and facilitate wealth creation

Inflation is one of the major constraints to wealth creation. The rate of return on your investment
should ideally be higher than the inflation rate. The inverse case would result in wealth erosion.
Investing in equities allows you to earn a high return rate that can potentially beat the inflation rate by a
large margin. This is how equities facilitate wealth creation in the long term. History is proof, stock
indexes have consistently outperformed return on debt and other investments instruments in the long
term.

Protection by SEBI

In India, the stock market is regulated by the Securities and Exchange Board of India (SEBI). Amongst
other functions, the regulatory framework created by SEBI is responsible for protecting the rights of all
investors. SEBI has been instrumental in reducing the advent of fraudulent activities by companies or
individuals.

Right shares and bonus shares

When a company requires additional capital, it can issue ‘rights shares’. A right issue ensures the
preservation of ownership and control of existing shareholders, and they receive priority to invest, over
other investors. Right shares are issued at a price lower than the market price of the company’s share.
So, existing investors can take up this advantage or otherwise renounce such rights.

Sometimes companies decide to issue bonus shares to their shareholders. Bonus shares are essentially
free shares that are given to existing shareholders. Often, bonus shares are issued instead of dividends.

Flexibility
An investor looking to make an entry into the stock market can start with a rather small investment.
Purchasing the stock of small-cap or mid-cap companies in smaller units would be the apt way forward.
Another great benefit of investing in equity is that you can buy, sell or hold shares whenever and for
however long you prefer.

Tax advantage

Equity investments offer tax benefits. Long-term capital gains (LTCG) up to Rs. 1 lakh from equity
investments are exempt from tax. Otherwise, LTCG of above Rs. 1 lakh is taxed at 10%. Short-term
capital gains (STCG) from equity investments are taxed at 15%. The return earned on debt or gold invites
a higher tax obligation than equities do.

Streamlined processes and transactions

The process of buying and selling stock is rather simple. One can buy stock with the help of a broker,
financial planner, or even online. It doesn't take much to set up an account and get it rolling. Buying and
selling stocks has been made effortless with the help of digitization.

Collateral against loans

This is one of the benefits of investing in equity funds that usually get lost in translation. As a
shareholder, you can pledge your investments in qualified shares or equity mutual funds with a bank
and get a loan against such investment. Once you repay the loan, the pledge can be rescinded.
Generally, banks allow loans up to 50% of the eligible shares or 50% of the value of equity mutual funds
owned.

Diversified investments

A general rule for investing is to diversify. The common adage is – “don’t put all your eggs in one
basket”. Diversification helps reduce risk concentration associated with a particular investment
instrument. Equity investments deliver an acute edge by diversification. Stock market fluctuations are
independent of other investments such as bonds and real estate. Adding stock to your portfolio means
greater risk but it also delivers sizable and rapid gains. This can also assist you, as an investor, to avoid
overly conservative investment strategies.

Importance of the Money Market

The money market is a market for short term transactions. Hence it is responsible for the liquidity in the
market. Following are the reasons why the money market is essential:

It maintains a balance between the supply of and demand for the monetary transactions done in the
market within a period of 6 months to one year..
It enables funds for businesses to grow and hence is responsible for the growth and development of the
economy.

It aids in the implementation of monetary policies.

It helps develop trade and industry in the country. Through various money market instruments, it
finances working capital requirements. It helps develop the trade in and out of the country.

The short term interest rates influence long term interest rates. The money market mobilises the
resources to the capital markets by way of interest rate control.

It helps in the functioning of the banks. It sets the cash reserve ratio and statutory liquid ratio for the
banks. It also engages their surplus funds towards short term assets to maintain money supply in the
market.

The current money market conditions are the result of previous monetary policies. Hence it acts as a
guide for devising new policies regarding short term money supply.

Instruments like T-bills, help the government raise short term funds. Otherwise, to fund projects, the
government will have to print more currency or take loans leading to inflation in the economy. Hence
the it is also responsible for controlling inflation

Advantages of Derivatives

Unsurprisingly, derivatives exert a significant impact on modern finance because they provide numerous
advantages to the financial markets:

1. Hedging risk exposure

Since the value of the derivatives is linked to the value of the underlying asset, the contracts are
primarily used for hedging risks. For example, an investor may purchase a derivative contract whose
value moves in the opposite direction to the value of an asset the investor owns. In this way, profits in
the derivative contract may offset losses in the underlying asset.

2. Underlying asset price determination

Derivatives are frequently used to determine the price of the underlying asset. For example, the spot
prices of the futures can serve as an approximation of a commodity price.

3. Market efficiency
It is considered that derivatives increase the efficiency of financial markets. By using derivative
contracts, one can replicate the payoff of the assets. Therefore, the prices of the underlying asset and
the associated derivative tend to be in equilibrium to avoid arbitrage opportunities.

4. Access to unavailable assets or markets

Derivatives can help organizations get access to otherwise unavailable assets or markets. By employing
interest rate swaps, a company may obtain a more favorable interest rate relative to interest rates
available from direct borrowing.

Capital markets refer to a platform where the trading of various assets like bonds, equity, and securities
takes place. Capital markets are mainly divided into two types- Primary Markets and Secondary Markets.

The primary market refers to a place where securities are created whereas the secondary market refers
to a place where these securities are traded. When a company raises capital for the first time, it is
known as the primary market. E.g.- companies issue Initial Public Offering (IPO) in the primary market
only. Shares issued by the company in the primary market get listed on the secondary market. All the
exchanges like BSE, NSE, NASDAQ, NYSE, german DAX, etc. come under the secondary market.

For example- Company ABC Limited hires underwriting firms to determine the financial details of its IPO.
The underwriters detail that the issue price of the stock will be Rs. 1,000. Investors can buy the shares of
this IPO at this price directly from the issuing company. Since this is the first opportunity that investors
have to contribute capital to a company through the purchase of its stock, it is called a primary market.

In another example, if you buy a stock of Reliance Industries Limited (RIL), you are dealing only with
another investor who owns shares in RIL. Reliance Industries itself is not involved in the transaction. This
is called the secondary market.

In other words, it can be said that while the primary market offers avenues for selling new securities to
investors, the secondary market is the market dealing in securities that are already issued by the
company.

Here are some of the major differences between Primary and Secondary Markets-
Primary Market

Secondary Market

Meaning

A marketplace for new shares

A marketplace where formerly issued securities are traded

Another Name

New Issue Market (NIM)

After Market

Products

IPO and FPO

Shares, debentures, warrants, derivatives, etc.

Type of Purchasing
Direct

Indirect

Parties of buying and selling

Buying and selling takes place between the company and investors

Buying and selling takes place between the investors

Intermediaries involved

Underwriters

Brokers

Price Levels

Remains Fixed

Fluctuates with variations in demand and supply

Financing provided to
It provides financing to the existing companies for facilitating growth and expansion.

No Financing is provided

Purchase Process

The purchase process happens directly in the primary market.

The company issuing the shares is not involved in the purchasing process.

Beneficiary

The beneficiary is the company

The beneficiary is the investor

Government involvement

A company issues shares and the government interferes in the process

There is no involvement of the government in the process.

The basic feature of the primary market is that it is associated with new issues. Primary market issues
capital through public issue, offering for sale, private placement, and right issue. Accordingly, capital is
raised for funding companies and the government. All the transactions are primarily made in the
primary market and the secondary market comes at a later stage.

The secondary market is known to provide liquidity to all the traders and any investor or seller who
needs money can sell their securities to any number of buyers. Any development in the securities leads
to price fluctuation in the market and the market adjusts itself to the price of the new securities.
Moreover, the transaction cost in the secondary market is lower due to the high number of transactions
as compared to transactions in the primary market.

Investors in the secondary market are bound to follow the rules and regulations as specified by various
stock exchanges and the government and these rules and regulations ensure the safety of securities of
the investors.

A financial system can be defined as either market-based or bank-based depending upon the manner in
which funds are raised in the economy. A system that relies heavily on selling securities in the open
market is considered to be a market-based system. Here, investors conduct their own due diligence and
bear their own risk when they lend money to corporations.

On the other hand, a financial system in which investors invest their money in banks and these banks
then invest the money in corporations is called a bank-based financial system. Here, the bank plays the
role of a gatekeeper i.e. they inspect the financials of the company on behalf of the investor before
making a final investment.

Both these methods of financing exist in almost every economy around the world. However, a system is
called a market-based or bank-based system depending upon the predominant system of investing
prevailing in that economy. This is generally measured by the percentage of banking services in the
overall economy.

For instance, if we compare the United States and Europe, we discover that the United States is a
market-based system whereas Europe is a bank-based system. This is because banking services as a
percentage of GDP are almost twice as large as in the United States.

It is important to note that economies cannot change from a bank based to market-based economies
overnight. Even the most advanced countries of the world like the ones in Western Europe take decades
to transition from one system to another. Hence, this can be considered to be a semi-permanent
characteristic of the market.