If you’re a market participant, you’ve probably heard of the terms White market, Black market, and, unexpectedly, Grey market. A white market is a market for commodities that are considered legitimate, official, and sanctioned. A black market is the polar opposite of a legitimate market.
A grey market, on the other hand, is a market that operates with the knowledge of the items’ owner but occurs outside of official trade channels. We’re going to take a closer look at the IPO grey market today.
An initial public offering (IPO) is a way for a company to generate funds for expansion and growth. For the investor, it could be a chance to get in on the ground floor of a rapidly expanding company. The majority of these shares are purchased through permitted methods, such as the SEBI-regulated stock market.
What is an Initial Public Offering (IPO) Grey Market?
In most cases, a successful IPO has all or nearly all of its shares subscribed or oversubscribed. In cases of oversubscription, shares are awarded on a pro-rata basis, or a lottery mechanism is used if the subscription is too high.
The chances of getting an allotment are exceedingly slim here. In these instances, investors look for potential sellers who have also applied for allotment on the grey market.
The term “grey IPO market” refers to when an IPO is sold on unauthorized or unregulated markets. A seller, buyer, and dealer are usually involved in the Grey Market.
1. The Seller is the person who really applies for shares with the intention of selling them on the black market.
2. The Dealer serves as a go-between for the buyer and seller.
3. The Buyer is the person who buys allocated or unallotted shares from the grey market in the IPO.
It is important to realize that the Grey Market is not governed by any regulatory organization. All of the agreement transactions take place on the basis of mutual trust.
An IPO’s timeline :-
When an investor participates in the white market IPO, he or she applies and bids on the day the IPO begins. The process of allocating shares takes about ten working days on average.
After the IPO closes, it takes two weeks for the shares to be listed and begin trading. When an investor participates in the grey IPO market, trading can begin before the IPO and continue long after the allocation has been completed.
How does the grey market work?
The trading in a grey market is done through a dealer or a mediator.
1. The Grey Market Premium is determined based on market demand and conditions. The amount above and above the asking price is known as the Grey Market Premium ( offering price is the price at which the company sells shares to investors in an IPO).
2. Buyers who are willing to pay this price reach an agreement with the mediators. The seller is then contacted by the mediator. Buyers’ bids might be submitted before or after the application is submitted.
3. The seller is subsequently assigned the shares. The mediator may instruct the seller to transfer the shares to the buyer’s Demat account as soon as the shares are listed, on the buyer’s request.
Alternatively, he can propose that the shares be sold in the stock market at the settlement price, with the proceeds going to the buyer.
There is no action that an individual can take if one of the parties defaults because there is no regulatory authority to supervise the transactions and all of the transfers take place online.
Price of Kostak and Kostak :-
It is conceivable for a person’s ‘Application for the IPO’ to be sold on the grey market. In exchange for the seller committing his IPO application to the buyer, the buyer will pay a fee known as the Kostak price. It makes no difference whether the application is allocated or not. Regardless, the buyer must pay the Kostak price to the seller.
Advantages of participating in the Grey market :-
The key advantage that buyers gain is an enhancement in their chances of receiving shares in the event of a subscription. It can take up to two weeks for the shares to be listed once they are closed.
The Grey market purchasers wager on the notion that prices will be higher on listing day than the unofficial price (including the Grey market premium) from the Grey market.
Once the equities are posted, the Buyer can sell them at a higher settlement price and profit. On the other side, the buyer is exposed to the danger of a price drop, which could result in a loss.
-For example, ABC Company sets the first public offering price at Rs. 150 per share.
The Grey market premium for ABC shares is established at Rs. 30 based on demand. The entire official price comes to Rs 180 in this situation.
The buyer will receive an Rs. 20 profit if the settlement price on a listing day is set at Rs.200. The buyer, on the other hand, loses Rs. 20 if the settlement price on the first day is fixed at Rs. 160.
-Taking Kostak into mind.
Assume the Kostak price for ABC company is set at Rs.100 and a single lot size is 100 shares, as in the previous example. The seller’s application was only for one lot. Let’s imagine the price is Rs. 200 in the example above.
The seller will sell the lot and send the profit to the buyer’s account in this case. The profit is 20(200-180) x 100 =2000 in this case. The Kostak amount owing is deducted from this amount, and the net gain is delivered to the buyer in exchange for taking on the risk.
In the same way, if the settlement price is Rs.160, the buyer will lose money because the price has fallen below the unofficial price and Rs 100 has been deducted from the Kostak price. The buyer must still pay the seller Rs. 100 if the seller does not receive an allotment for his application.
If the seller’s application is not approved, the buyer will also suffer a loss. As a result, in order to decrease the risk of non-allocation, he strikes a deal with a large number of suppliers. If the IPO is three times oversubscribed, he enters into an agreement with numerous sellers to avoid the risk of loss due to Kostak price non-allocation.
Final Thoughts :-
The Grey market also serves to inform other investors about the potential demand for a company’s shares, allowing the investor to change his application accordingly. The demand may also imply a potential trading price for the shares after they are listed.
The corporation or the underwriter may potentially use the Grey market to boost demand for the shares. As a result, before utilizing the Grey market as a benchmark, keep in mind that it is prone to manipulation. Furthermore, the stock market is a high-risk environment. Due to the lack of a regulatory agency and the inability to quantify the risk of trust, the grey market simply adds to the danger.
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