Financial markets are significant to the economy of any country. They provide individuals with a way to invest. Organisations also benefit by availing themselves of these services to improve financial resources. In such cases, money market vs capital market is the general comparison that is made to get to understand these two areas better. Understanding the money market vs capital market is important; however, knowing about their basic features is also important which we will cover in this blog.
Money Market Definition:
There are multiple money market definitions. Let’s look at this two money market definition to understand it better.
Author Geoffrey Crowther in his book “An Outline of Money” has stated :
“Money market is a collective name given to the various forms and institutions that deal with the various grades of near money.”
( Source: The strategy watch)
Another money market definition quoted by Nadler and Shipman, "A money market is a mechanical device through which short-term funds are loaned and borrowed through which a large part of the financial transactions of a particular country or world are degraded. A money market is distinct from but supplementary to the commercial banking system."
(Source: thetreasurenotes)
Types of Money Market
There are different types of money market instruments, each of them being used to increase the gross domestic product of a nation. It also generates returns with security for those investors who are looking to invest in low-risk propositions with a short tenure.
Here is a list of examples of money markets:
- Certificate of Deposit
Lending significant financial resources to an organisation can be done against a certificate of deposit. The operating procedure is much like that of a fixed deposit, except for the higher negotiating capacity, as well as the lower liquidity of the former.
- Commercial Paper
This is a kind of money market instrument which acts as a promissory note raised by a company to collect short-term funds. It is unsecured and therefore can be utilised only by large-cap companies with excellent market reputations.
The maturity period of these debt instruments is between 7 days to one year; hence, the interest rate on offer is lesser as compared to equivalent securities offered in the capital market.
- Treasury Bills
These are issued by the central government of a country only when it requires funds to meet its short-term obligations.
These securities do not incur interest but allow an investor to gain capital as it sell at a discounted rate with the entire face value at the time of maturity.
Since treasury bills are secured by the government, default risk is almost nil, and thus it is taken to be an ideal investment vehicle for risk-averse investors.
- Repurchase Agreements
Commonly called Repo, it is one form of short-term financing instrument through which the borrowing issuer is obliged to repay (repurchase) that in the future.
Usually, repurchase agreements typically involve the exchange of government securities. They are subject to market interest rates and are backed by the government.
- Banker's Acceptance
One of the widely traded money market instruments within the financial sector, the banker's acceptance is a loan made to the bank specified. The guarantee of repayment in the future is signed.
Money market instruments are traded over the counter wholesale. This means that it cannot be bought in standard units by an individual investor.
Money market instruments, however, are available for investment through money market mutual funds. The latter are interest-earning open-ended funds and thus carry very low risks given their short maturity period as well as the collateral guarantee offered by the central government in most cases.
Money market investments should ideally be taken up when the stock market poses a great degree of volatility. At this time, investing in equity and debt instruments in the capital market has high risk associated with it, as the chances of underperforming are immense.
The government, in general, tries to increase the money circulation in the country to reduce market fluctuations. Therefore, government-backed instruments provide higher returns in such conditions to increase the demand for the same. To know more about the money market and its function, check out the blog here.
Capital Market Definition
The capital market definition is "a financial market in which long-term debt or equity-backed securities are bought and sold, typically used to raise funds for businesses and governments" is a general description commonly found in financial literature.
The capital market is further divided into two parts:
- Primary Markets- New equity bonds and securities are sold to investors.
- Secondary Markets- Trade of existing securities
Primary Markets
A company engages in the primary capital market when it publicly sells new stocks or bonds for the first time, such as in an initial public offering (IPO). This market is sometimes referred to as the new issues market. The company that offers the securities hires an underwriting firm when investors purchase securities on the primary capital market. It goes to the house and writes a prospectus that spells out the issue price and any other detail concerning the securities to raise cash for business operations.
Any issues through the primary market are always highly regulated. Firms have to first file their statements with the SEC and all other agencies offering securities before they can publicly issue any of the issued securities.
Small investors frequently cannot purchase securities on the primary market since the corporation and its investment bankers want to sell all the available securities during a short period in order to meet the required volume. They must focus on the marketing of sales to institutional investors who can purchase more quantities of securities at one single time.
Marketing the sale to investors is often a roadshow, or dog and pony show, in which investment bankers, along with the company's leadership, travel to meet with prospective investors, convincing them that the value of the security being issued is worthwhile.
Secondary Markets
The secondary market involves venues regulated by an independent regulatory body such as the SEC where these already-issued securities are traded between investors. Issuing companies don't have a stake in the secondary market. NSE, BSE, NYSE and Nasdaq are some examples of the secondary markets.
The auction market and the dealer market form the two categories in the secondary market. The auction market is where the open outcry system is found where buyers and sellers will usually gather in one location, and they will advertise prices at which they're ready to buy and sell their respective securities. The NYSE is one such example. People trade through electronic networks in dealer markets. Most small investors trade through dealer markets.
Types of capital markets
- Equity Market: Shares like Infosys, Reliance, HDFC being traded in NSE and BSE
- Debt Market: Government Securities (G-Secs) issued by the Reserve Bank of India.Corporate bonds by companies like Tata Steel and NTPC.
- Derivatives Market: Equity Futures and Options on NSE. Currency and commodity Derivatives on Multi Commodity Exchange (MCX).
- Mutual Funds: Available for companies such as SBI Mutual Fund, HDFC Mutual Fund, and ICICI Prudential Mutual Fund.
- Exchange-Traded Funds (ETFs): Bharat 22 ETF and Nippon India ETF.
Globally
- New York Stock Exchange (NYSE) Trading equities of the companies, such as Apple and Microsoft.
- The NASDAQ is a leading hub for tech stocks such as Google and Amazon.
- London Stock Exchange (LSE): It is famous for share dealing in global companies, like BP and HSBC.
These examples showcase how capital markets provide platforms for investment, trading, and economic growth. To know more about capital markets, check out the blog here.
Difference between money market vs capital market
Difference between money market vs capital market
To sum it up and to make the concepts much clearer and easier to understand, presenting the differences between the money market vs capital market in a tabular format.
(Source: ClearTax)
Check out this video to know about the money market vs capital market in detail.
FAQs
Q1: What is the main difference between money market and capital market?
Ans: The money market works with short-term financial products such as Treasury Bills and Commercial Papers, whereas the capital market works with long-term securities such as stocks and bonds.
Q2: What are the types of capital markets?
Ans: Some examples of capital markets are: equity markets, debt markets, derivatives markets, mutual funds, and exchange-traded funds.
Q3: Why is the money market considered low-risk?
Ans: The money market is less risky in that it consists of highly liquid short-term instruments backed by such stable institutions as central banks and governments.
Conclusion:
The money market and the capital market are the two fundamental segments of the economy which support short-term liquidity requirements as well as long-term investment demands. Understanding their differences empowers the individual and the organizations in making proper financial decisions.
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