Introduction to IPO GMP
A company needs money for operations. There are two ways to raise funds: owned funds and borrowed funds. In further categorization, we have also learned that owned funds are of two types, that is IPO (Initial Public Offering) and FPO (Follow-on Public Offering).
Today, we will introduce you to a new share market terminology in the IPO, which is GMP (Grey Market Premium).
What if we tell you there’s a market operating where you can demand the newly issued shares even before they are listed on stock exchanges? Interesting right? Well, we are talking about IPO GMP.
But what is IPO Grey Market Premium?
In IPO, Grey Market Premium offers investors such opportunity where the investor can put a demand for newly issued shares before they are listed. GMP means Grey Market Premium. This market is also known as the parallel market.
Simply put, GMP is the additional amount at which Initial Public Offering shares are traded in a parallel market before getting listed. It’s an unofficial market outside the stock market.
For example, if a company is willing to offer its shares in the initial public offering at ₹120 and the investor is willing to pay a premium on the price and the grey market premium is fixed as ₹20, now you can predict the listing at approx ₹140 in the stock market.
What is GMP?
Grey Market Premium, popularly known as GMP, is the difference between the issue price at which the shares are listed and the price at the grey market before listing.
To understand better, if the issue price is ₹350 and investors are willing to pay ₹420 for that IPO share. The GMP of the Initial Public Offering is ₹70 (420–350).
GMP helps to anticipate listing prices. As given in the above example, the listing price can be ₹420, i.e. issue price + GMP (350+70). However, there is no perfect formula to prove this anticipation as 100% right. The pricing also depends upon certain other factors before it gets listed.
Are Grey Markets legal?
Although grey markets are unofficial and informal, it is not illegal. It is simply an unofficial way of trading shares not governed by SEBI, like primary and secondary markets.
There are no exact rules and regulations to run a grey market, but these markets run of trust. The entire process of the grey market runs based on the demand and supply of that Initial Public Offering.
How do you calculate the GMP of an Initial Public Offering?
There’s a formula to calculate the rate of premium in GMP that is,
Grey market premium rate = GMP * Number of shares
- The investor first needs to gather information about the initial public offering, the company, and the GMP’s latest price.
- Now to determine the GMP, subtract the issue price from the initial public offering grey market price
- The last step is to calculate the grey market premium percentage. Simply divide the GMP by the issue price and multiply it by 100
To take an example,
If the issue price is ₹100 per share and the initial public offering grey market price is ₹104. The GMP IPO is (104-100), i.e. ₹4.
To calculate the percentage = 4/100*100 = 4%
Types of GMP IPO
1. Grey market premium IPO
Simple buying and selling of Initial Public Offering shares before it’s listed in the stock exchanges is GMP IPO. It can be positive or negative.
For example,
• If the GMP is positive and the Initial Public Offering is suggested to perform better upon listing. Let’s take the issue price of ₹200 and the grey market premium is ₹50, the listing could be ₹250.
• If the GMP is negative and the performance of the Initial Public Offering is uncertain upon listing. Let’s take the issue price to be ₹200 and the grey market premium (-₹80), the listing could be expected at ₹120.
2. Kostak rate
The Kostak rate is a pre-agreed price at which Initial Public Offering applications are traded.
However, the allotment status is still not guaranteed. It is a price decided mutually between the buyer and the seller.
The seller regardless of the allotment, needs to pay the fixed premium to the buyer in this case.
Let’s understand with example
Aman applied for one lot of Mama Earth IPO for which he paid Application money of ₹ 15,000, but he is unsure of getting the IPO or is worried it might be listed below the IPO price. Whereas, Ritam is sure the IPO will be listed above IPO price but he doesn’t want to take the risk.
Ritam approached Aman and offered to pay him ₹ 5,000 in exchange for his entire lot. Aman accepted the offer. Now on the IPO date, let’s say Aman did get the IPO, and the Share Price went down, and that lot is now worth ₹9,000. Ritam will not get the shares, but Aman will keep the ₹ 5,000.
Here, Aman profited from the deal by limiting his loss to ₹ 1,000. How? His shares are worth ₹9,000, but he also received ₹ 5,000 from Ritam. In total he received ₹14,000 against his investment of ₹15,000.
Whereas Ritam limited his loss to ₹ 5,000, which would have been ₹6,000 had he applied directly to the IPO.
This ₹ 5,000 that Ritam paid to Aman is called Kostack.
Now, if the situation had been reversed and that IPO opened up at ₹ 17,000. Now Aman would have made a loss of ₹10,000 (Initial investment ₹15000- Received from Ritam ₹5000). But Ritam would have made ₹12,000 (Valuation ₹17000 – ₹5000 paid to Aman).
Also if Ritam would have paid the Kostock amount to Aman irrespective of IPO allotment status.
3. Subject to Sauda
Subject to Sauda is an extension to Kostak’s rate. As the term “Sauda” (Sauda is a Hindi term which means agreement or deal between two or more parties upon certain transaction, whether monetary or not) suggests, it is an agreement between two parties.
In this case, the buyer agreed to pay a fixed price against the application only in case the seller receives the allotment of shares. This reduces the risk to the seller. However, subject Sauda rates are always higher than Kostak rates because of lesser risk.
So had the deal between Aman and Ritam been a Sauda Deal, Ritam would have paid Aman only if he had been allotted the share.
Factors influencing GMP IPO
Several factors influence the grey market premium, some of which are,
1. Demand and supply
As suggested, the rate of premium in GMP is based upon the demand and supply of that Initial Public Offering, it is an important factor influencing GMP. The higher the demand, the higher the grey market premium.
2. Price valuation
The company’s price valuation of the IPO plays a major role in GMP IPO. If the company is undervalued as per the investors and market, the GMP can be anticipated to be higher.
3. Company’s business model
The company’s fundamentals and its business model play a prominent role in GMP IPO. A company with strong financial and goodwill has a chance of higher GMP rates.
4. IPO size
The larger the initial public offering, the lesser the GMP rate. Since there are more shares available for trade, the demand will reduce for investors who are willing to pay a higher price.
Factors like market conditions, promoters’ track record, market intelligence, and reactions will also influence the GMP IPO.
Risk of GMP IPO
There are certain risks associated with grey market premiums in IPO.
Lack of regulation
There are no official regulation regulations in this market, and thus the risk is higher than usual.
Speculation risk
The rates are volatile and are completely based on speculations made keeping in mind certain factors. The actual price can be different
Lack of allotment guarantee
Even though the demand is strong, there is no guarantee of allotment of shares. Allotment of shares after an Initial Public Offering depends upon various factors and thus can be risky.
Due to these risks, it is advisable not to involve yourself in grey market transactions. But you can use this data to judge an IPO. GMP can be one of the factors to make the decision to apply for an IPO or not.
If the company is fundamentally good and the IPO gets over-subscribed
Bottom line
To conclude, grey market premium in IPO is the premium investors pay to invest in that Initial Public Offering before it gets listed.
While it is risky and unofficial, it’s based on trust and mutual agreement and thus can be beneficial to the parties.
There are types of grey market premium available in initial public offering including basic GMP IPO, Kostak rates, and, subject to Sauda agreements.
However is it important for investors to make proper calculations and analysis before deciding for grey market premium in an IPO? There are a lot of factors and features of grey market premium IPO which need important consideration before taking any action.
While in the other hand, the legality of the GMP is still a question and thus we do not promote trading in GMP IPO. We advise the investors to stay cautious while relying on this evaluation and make their investment decisions, keeping all the prominent factors in mind.
FAQs
- Is the grey market different from the regular stock market?
A grey Market is a market where a company’s shares are traded unofficially before they are listed on a stock exchange. Whereas the stock market is a market where securities are traded after it is listed on the stock exchange and this market is regulated by the norms of SEBI. - What is the grey market premium rate?
The difference between the issue price of the listed security and the price at the grey market before it is listed, is the grey market premium rate. - Are there any risks associated with the GMP IPO?
Yes, since the grey market is not regulated under SEBI and is built on trust, there’s a risk of lack of regulation, speculations, chances of loss, etc. - How does the GMP IPO help the investor?
Grey Market Premium in IPO helps the investor predict the price at which the stocks are expected to be listed. - Is GMP always positive?
GMP can be both positive and negative depending on the stock performance, market reaction to IPO, and the company’s fundamentals.