Price Band Definition

The stock exchange dismisses orders falling behind or exceeding the price band. If the stock rate touches the l/u price limit, orders will remain pending until the relaxation of limits. Therefore, the price band can be considered as boundaries of trading price. It is generally used during an Initial Public OfferingInitial Public OfferingAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more (IPO). 

Key Takeaways

  • The price band refers to a stock’s highest (cap) and lowest (floor) value range within a single trading day, usually employed during an Initial Public Offering (IPO). It is set by the stock exchange or seller for the buyer or company to prevent market volatility and limit panic selling. The seller rejects any orders lower or higher than the designated range of values.

Price Band Explained

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The price band stipulates a border for stock tradingStock TradingStock trading refers to buying and selling shares of an entity listed on a stock exchange.read more wherein the seller allocates the buyer’s highest (cap) and lowest (floor) cost limit. It averts unexpected massive stock price fluctuations. This is the cost limit for a stock to be traded during that specific day. Note that the spreadSpreadSpread is the price, interest rate, or yield differentials of stocks, bonds, futures contracts, options, and currency pairs of related quantities.read more between the floor and cap price must be a maximum of 20%.  

Let’s discuss the two main prospects. 

  • The stock rate at the upper limit – Pending orders as bids at an upper price. Therefore no market offers or sellers. The stock rate at the lower limit – Pending orders on the offer side at a lower price, hence no market bids or buyers.

Say the value of an underlying security increases or decreases by 20% of the opening price or during a designated time frame. Subsequently, the stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more would discontinue its trading for a moment till the markets are settled. It lets sellers and buyers conveniently discover each other. 

Price band identification lets a company acknowledge how much the investors wish to pay for proprietorship. In other words, this helps the firm analyze its market worth. It promotes an organized stock market atmosphere and is also called “circuit limits.” 

The rate at which the IPO issue gets listed is labeled as the “cut-off price”. So, for example, suppose the value limits in IPO are between $200 and $400 and it is listed at 350, then 350 is the cut-off price. 

The stock exchange regularly publishes the underlying security’s lower and upper price limits. In addition, many nations set a lower and upper limits for international trade. Goods costing less than the lower price limit are subject to duties or taxes for inclusion into the range. 

The price band in IPO refers to the bidding flexibility of stock and is subject to revisions. Therefore, the bidding period must be expanded for 3-13 days upon every revision. 

As per their volatility, stocks are categorized into 5%, 10%, 15%, and 20%. Therefore, large market traders can effortlessly control the rates of small and micro-capMicro-capStocks with a market capitalization of $50 million to $300 million are known as micro-caps. The market capitalization of such stocks is higher than that of nano-cap firms, but lower than that of small-cap, mid-cap, and large-cap companies.read more stocks that are put into the 5% group. 

How to Decide the Price Band?

Computation of a logical price band requires quantitative analysis, extensive research, and calculation. Therefore, companies opt for the book-building process to offer securities to several bid procedures. This assists analyze the securities’ market demand and fixing an effective price band. In addition, companies often employ underwritersUnderwritersAn underwriter is an individual or an institution who is involved in the act of underwriting the issue of securities of a company for a fee.read more who study several factors related to the company and market to finalize a definitive price range built into books.

Factors Affecting the Price Band in IPO

The companies and investment bankers determine the price band in IPO, keeping the below-mentioned factors in mind. 

  • Basic complete market trendLeadership and departmental set-up of the private organizationQuality of stocks being sold in IPOFuture growth capability of the companyThe current market rate of the stocks in companies from the same sectorThe demand for company stocks from prospective customersFiscal efficacy of the firm’s business modelAny good news demonstrating achievements of the company

Example

Let’s say a firm, ABC Ltd., issues 20,000 stocks in the IPO price band of $50-$100. Here are the bids from investors.

The cut-off price (highest rate to sell the issue) is $85. Moreover, the total number of shares all investors wish to purchase is 25,500. Thus, 5500 shares are more than the available quantity. Consequently, ABC Ltd. won’t assign any stock to bidders lower than $85 and will reimburse their amount.

This has been a Guide to What is Price Band and its Meaning. Here we discuss how to decide the price band and the factors deciding it along with an example. You may also have a look at the following articles to learn more –

The company owners discuss the IPO price band with investment bankers. They generally employ the book-building procedure for offering securities to numerous bid processes. It helps identify the securities’ market demand and set a fair price band.

The NSE (National Stock Exchange) has specified price bands for all underlying securities. This helps sellers know how much the investors are willing to pay to obtain company ownership.

  1. The overall common market trend2. The demand of the company shares from potential clients 3. Company’s future growth ability 4. Management & leadership of the private firm 5. Quality of stocks being sold 6. Any positive news about the company 7. The prevailing market rate of the shares in similar companies belonging to the same category 8. Financial competence of the company’s business model

A fair price band avoids the sudden undesirable market deviations to sustain a controlled mass trading environment. Also, it avoids the probability of panic selling.

  • Psychological PricingRed Herring ProspectusIrrational Exuberance