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Financial Literacy

The Grey Market Defined and Explained

The grey market is an uncommon investment term. But here at Investment U, we try to cover it all. Our goal is to provide an investment education, tuition-free. So today, let’s add another term to our vocabulary.

The short guide below explains two different use cases of a grey market. The first deals with buying and selling goods. And the second definition ties into the IPO market.

What is a Grey Market?

The grey market is legal but unofficial and unregulated.

A grey market is an unofficial but legal market to sell goods outside of a brand’s distribution channels. This is typical when a product sells at a much higher price in one country and a lower price in another. The seller will buy the product at the low price, sometimes wholesale. They then turn around and sell it at a price high enough to make a profit but lower than the authorized retail price.

This practice is common around the holidays. When companies can’t keep up with the high demand of products, grey market sellers take advantage. They sell the product usually at a much higher price.

This shouldn’t be confused with a black market. A grey market is unregulated but legal. A black market involves the smuggling of illegal or restricted products.

IPO Grey Market

The definition above is the general-use case. However, the term can also apply to investing around certain IPOs. This happens when trading is done over the counter (OTC) in special situations.

An IPO grey market is an unofficial but legal market to buy and sell shares. There are no regulated platforms or rules to guide the process. Securities are traded directly between parties. And in pre-IPO cases, the price can be a prediction of the company’s value at the end of its first day on the market.

There isn’t a public record of trading prices, which makes pricing securities difficult. When a trade is made, it’s binding. However, a trade can’t be settled until securities are officially trading on the exchange. This increases the risk of deals falling through.

Side note: Grey market trading doesn’t apply only to pre-IPO cases. It can also happen after a public company is delisted from an exchange.

How the Grey Market Affects the IPO Process

The IPO process is lengthy and time-consuming. But there is one part of it that’s important for a successful IPO – the roadshow.

Although an IPO roadshow typically involves a sales pitch of the company, it has one basic goal. The underwriters need to build and gauge the demand for securities. By uncovering any activity on the IPO grey market, underwriters can get a better estimate on demand and pricing.

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