IPO-Grey Market Premium
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IPO-Grey Market Premium

Introduction-GMP

If you invest in IPOs or keep a track of them, then you must have heard about the term ‘Grey Market Premium’. But what is it, is it legal and does it indicate the future price of upcoming IPOs? All your queries will be solved. But first, you have to learn about the three different types of market. Only then, you will be able to understand the actual meaning of Grey Market Premium.

Types of Markets

There are three different types of markets.

1. White Market-

(i)It is an open and legal market.

(ii)The law of the land is followed and hence this is trustworthy.

(iii)Some of the examples are trading in the National Stock Exchange/Bombay Stock Exchange.

2. Black Market-

(i)It is an illegal market.

(ii)The law is bypassed to avoid price control and taxes.

(iii)An example of a black market is smuggling.

3. Grey Market-

(i)Grey Market is a parallel and over-the-counter market but it is not illegal.

(ii)Deals take place through an unofficial channel.

(iii)An example of a grey market is an IPO Grey Market.

Now, it will be easy to understand the IPO Grey Market Premium.

Terminologies associated with Grey Market.

1.Grey Market Premium (GMP).

2.Kostak Rate.

3.Sauda Rate.

Grey Market Premium

Grey Market Premium(GMP) is a term used to estimate the price at which the IPO will be listed. Grey Market is unofficial but investors keep an eye on it. Grey Market operates before the listing, from the IPO start date to the allotment date. Grey Market Premium indicates the reaction of IPO on listing day with an estimated price. Now, for example, there is a stock with an IPO price of Rs.100 and a Grey Market Premium of Rs.20, which means that there is a possibility of the stock getting listed at Rs.120. 

Kostak Rate

Kostak Rate (or price of application) is the premium amount at which IPO applications are being traded in the grey market. In other words, Kostak Rate is a profit one makes by selling his/her IPO applications even before allotment or listing of the issue. It is especially useful for people who do not want to take a risk with IPO allotment or listing gains.

Sauda Rate

The amount decided when the investors receive the firm allotment on their IPO application is referred to as the Subject to Sauda. If one buys or sells the IPO application on the subject to sauda, it means that one can receive the stated amount if the allotment is successful; otherwise, sauda will be canceled. The profit, in this case, is determined by the allotment. Again, if one receives an allotment and sells the application for around rupees 100000, and the profit on a listing day is around rupees 150000, he will have to pay rupees 50000 to the person who purchased the application.

Why do people trade in the Grey Market?

There are three basic reasons why people trade in the grey market:-

1. Grey Market provides an opportunity for retail investors and traders to purchase the shares before they are listed if they feel that the stock is going to increase in value.

2. if an investor wants to exit an IPO even before it is listed, the grey market provides him/her a way out. Basically, it can be used to reduce risk factors.

3. It allows people to purchase IPO shares even though they missed the application deadline or if they want to buy even more shares than the IPO application could provide them with.

Why do businesses allow such trading?

1. The businesses that want to opt for IPO, test the demand for their shares in the grey market. It is also a place for the stocks that are waiting to be listed on the big exchanges or don’t qualify for the same.

2. Not all stocks are related to IPO, some grey market stocks are issued by startups or spin-off companies to test before spending time and money to list on a major exchange.

The Unpredictability of GMP with examples

The GMP reflects its market sentiment, which is a barometer that people want to pay now.

Let’s take two contrasting examples.

(i)Infosys IPO was undersubscribed in 1993 because the general investing sentiments were very low for the company and has been a multi-bagger since its listing.

(ii)A day before the listing of Reliance Power IPO in 2008, the grey market premium was 80% above the IPO price. But after the stock got listed the stock price crashed and the rest is history.

This means GMP only indicates the market sentiments and is not fully reliable.

 

Conclusion

“In the short run, a market is a voting machine but in the long run, it is a weighing machine.”-Benjamin Graham.

GMP is the vote and as an investor, you have to look for the weight. This means if you want to survive in the long run, then you can not rely upon the unpredictability of the Grey Market Premium.

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  • Author : Tushar Gera

    2021-09-14 12:57:53

    B.Com Hons. student and a part time blogger.