Primary Market and Floatation Cost

In the capital market, companies often need to raise long-term funds for various purposes such as expansion, capital investments, or acquisitions. One of the common methods used by companies to raise funds is through the primary market. The primary market is where securities are issued for the first time and sold directly to investors.

Floatation cost refers to the expenses incurred by a company when it goes public or issues new securities in the primary market. These costs include underwriting fees, legal fees, registration fees, printing costs, and other expenses associated with the issuance of securities. Floatation costs are deducted from the total proceeds of the securities issuance and can significantly impact the amount of funds raised by the company.

Instruments of the Primary Market

There are various instruments available in the primary market to raise funds, and each instrument serves a specific purpose. In this case, the company needs to raise funds to buy machinery, and therefore, it requires an instrument that can help meet the floatation cost. Among the given options, the instrument that best fits this requirement is Commercial Paper (option C).

Commercial Paper (CP)

Commercial Paper is a short-term debt instrument issued by companies to raise funds for their working capital needs. It is typically issued for a period of 30 to 270 days. CP is an unsecured instrument, meaning that it is not backed by any collateral. It is issued at a discount to its face value and is redeemed at par upon maturity.

Commercial Paper can be issued in the primary market to raise funds for various purposes, including meeting floatation costs. By issuing CP, the XYZ company can raise funds quickly and at a lower cost compared to other sources of finance. The proceeds from the issuance of CP can then be used to cover the floatation costs associated with raising long-term funds to buy machinery.

Conclusion

In conclusion, when a company needs to raise long-term funds in the capital market, it incurs floatation costs. To meet these costs, the company can issue Commercial Paper in the primary market. Commercial Paper is a short-term debt instrument that can be issued quickly and at a lower cost compared to other sources of finance. By choosing option C, the XYZ company can raise the necessary funds to cover the floatation costs and proceed with buying the machinery.