Difference Between Money Market and Capital Market

Money market and capital market are two wings of the financial market. Major players in the financial market, such as business organisations and governments, primarily trade in assets. The assets traded include stocks and bonds of a company, currencies, commodities, and derivatives.

The difference between money market and capital market is the result of short-term and long-term trading between these players. Firstly, money markets consist of lending and borrowing of short-term liquid assets. On the other hand, capital markets facilitate the trading of long-term securities that influence the value of capital.

Being aware of money market and capital market difference is important for students of commerce as well as other disciplines. It is because this knowledge enables them to understand the cause-and-effect behind several global and commercial trends. Therefore, the first step towards understanding the differences starts with grasping what they are and how they operate in the economy.

The Money Market: What is It?

Money market is primarily the section of the financial market that deals in short-term debt instruments. These debt instruments include money, certificate of deposit, and forward rate agreements. In addition, commercial entities can also trade money, treasury bills, and commercial papers in the money market.

First of all, financial institutions such as banks and Non-Banking Financial Companies (NBFCs) are the main agents within this market. However, the money market also accommodates bill brokers and money dealers. These agents collectively trade using highly liquid debt instruments in this particular financial market.

The most important feature of these tools of borrowing and lending is that they can be traded in the short-term. Typically, the transactions and trading in this market happen within a period of 1-year. It ensures that there is enough cash-flow between institutions like corporations and governments. Moreover, the money market allows its players to exchange these instruments even within a single day. As a result, the assets in the money market carry immense liquidity.

For instance, let’s consider one of the simplest money market examples. There are two banks – Bank A and Bank B. In case Bank A and Bank B carry on transactions of liquid assets between them, they become a part of the money market. Additionally, the money market also helps a business raise short-term working capital by selling commercial paper.

However, in terms of treasury bills, primary dealers or wholesalers buy a bulk from the government. These treasury bills are then traded between themselves or other investors. Therefore, it becomes important to learn more about types of money market instruments.

What are the Money Market Instrument Types?

There is a wide range of money market instruments that contribute to the proper functioning of a money market. Various types of money market instruments ensure that an organisation has enough storage of short-term surplus funds. As a result, companies trade in the money market to reduce their short term deficits.

Therefore, it becomes necessary to understand the different types of money market instruments. In addition, knowing about some money market instrument types will also help one to differentiate it from capital market instruments.

Thus, the most prevailing instruments that make up the money market include the following –

Certificate of Deposits (CDs) – Individuals or businesses receive Certificate of Deposits (CDs) as a receipt for the money they deposit in banks or other financial institutions. However, they receive CDs only when they deposit a large sum of money. Also, CDs enhance the importance of the money market in several ways.

CDs are exposed to relatively lower market risks and therefore form an important aspect of short-term surplus. In addition, the interest rates offered on this short-term instrument are also higher than treasury bills.

For example, Banks usually issue CDs for a minimum price of Rs.1 lakh. Higher amounts are multiples of Rs.1 lakh. The short-term maturity period for CDs generally ranges between 7 days and 1 year.

Commercial Papers (CPs) – Commercial Papers (CPs) refer to unsecured promissory notes that companies issue for short-term working capital demands. Therefore, organisations trade CPs in the money market to raise capital to fund their business requirements.

The period of maturity for CPs usually varies between 1 day and 9 months. As a result, CPs serve as an important tool for short-term capital requirements. On top of that, these assure higher returns are subsequently traded in secondary markets.

Treasury Bills (T-Bills) – Being a zero-risk money market instrument, Treasury Bills (T Bills) are distributed by the Central Government. Even though T-Bills are risk-free instruments of transaction, the monetary returns on these are minimal.

These bills are traded in both the primary market and secondary market. In addition, T-Bills come with a maturity period of 3 months, 6 months, and 1 year consecutively.

Organisations purchase T-Bills at a lower price than its actual face value. For example, assume that you’re buying a T-Bill at Rs.98 whereas its face value is Rs.100. Therefore, you will receive exactly Rs.100 when you sell it in the money market.

However, other types of money market instruments include Banker’s Acceptance (BA) – a future payment promised by a commercial bank, and Repurchase Agreements – short-term loans for the purpose of repurchasing and selling.

Now as money market meaning is clear, it’s time to move on to the idea of capital markets. As a result, understanding the concepts in the money market will certainly help you find the money market and capital market difference.

The Capital Market: What is It?

Unlike the short-term feature of money markets, capital markets are characterised by long-term trading. As a result, corporations and governments trade debt and securities supported by equity in the capital market. The transactions in the capital market assume the form of debentures, bonds, equity, and securities.

In addition, the capital market also allows the trading of company stocks and shares. These long-term capital market instruments make up for higher returns to the investors. However, the capital market is prone to financial risks and global commercial trends. Exchange of long-term securities actively indicates the financial performance of a corporation or an economy.

Capital market comprises both primary markets and secondary markets. First of all, individuals and organisations trade new stocks and securities in the primary market. On the other hand, secondary markets allow the transaction of previously-issued debt instruments. Additionally, capital market further branches into the stock market and bond market.

The long-term element in capital markets usually involve time periods between 3 and 10 years. Therefore, assets traded in these markets have less liquidity.

For example, in investor Mr. Thomas purchases a bond with a principal value of Rs.5,000 from a company. This company offers a coupon rate of interest at 5% for a maturity period of 10 years. Therefore, Mr. Thomas will receive Rs.5,000 at the end of 10 years, along with the accumulated interest.

Therefore, capital markets form the basis of long-term trading of debt instruments securities backed by equity. However, an individual must know the types of capital market instruments to be better able to understand the difference between money market and capital market.

What are the Capital Market Instrument Types?

There are various types of capital market instruments. Additionally, these capital market instruments help companies and investors alike to trade securities conveniently. These capital market instruments have significant immunity against market risks.

Capital market tools are essential for stockbrokers, stock exchanges, independent investors, commercial banks, and mutual funds. However, the most prominent instruments of capital markets are as follows –

·   Stocks – Investors and organisations trade stocks in the stock market as a means to gain ownership in a company. Therefore, stocks are essentially equity securities that imply an investor’s proportion of ownership in a corporation.

Companies issue public offerings at stock markets such as Bombay Stock Exchange and National Stock Exchange. Consequently, investors trade stocks of multiple companies among themselves as a means to gain capital. On the other hand, stocks are an important debt instrument that helps a company acquire capital for its business operations.

Besides, stocks are exposed to market risks and their dividends vary according to market trends. Therefore, stock prices are influenced by the financial performance of a corporation in the capital market. A high performing company offers stocks at higher values.

For instance, Mr. Kapoor decides to purchase 50 shares from a company that has a stock of 500 shares. Therefore, Mr. Kapoor has a claim of 10% to the assets and income of the company.

·       Bonds – Bonds are long-term loans that investors and creditors issue to companies looking to raise capital. Bonds refer to a fixed income instrument since companies have a legal obligation to return the face value of the bonds to the investors. The maturity period of bonds usually varies between 3 years and 10 years.

However, creditors are guaranteed to receive the face value of the bond, along with the interest accumulated over the maturity period.

These capital debt instruments have either fixed or variable rates of interest at which they are traded as security assets. Corporations, municipalities, and governments trade bonds in both primary and secondary markets.

·       Debentures – Debentures are non-securitised trading instruments that form a considerable portion of capital markets. Additionally, debentures lack a collateral equivalent to its value. As a result, investors have to consider factors such as the rating and creditworthiness of organisations that issue debentures.

Similar to several categories of bonds, debentures also carry indentures – a legal contract between institutions and creditors.

On top of that, debentures are characterised by fixed or variable interest pay-outs, and a long-term maturity date. However, debentures have lower interest rates in the capital markets in comparison with other debt instruments.

Let’s suppose that a highly reputed and creditworthy corporation ABC decides to raise capital with the help of debentures. On the other hand, investors are aware of the financial reputation of ABC. Therefore, they may purchase debentures issued by ABC without collateral because they have faith that ABC will not default. Therefore, an investor is eligible to receive the principal amount and interest on the debenture without having exclusive claim to a company’s assets.

Therefore, understanding the key concepts of the money market and capital market is important to understand the differences between them. As a result, the elements of the money market vs capital market will become clear to students.

Difference Between Money Market and Capital Market

After the detailed discussion on the features and types of money and capital markets, their differences become obvious. However, the finer points of difference can be broadly classified into the following factors –

·   Trade Period – As their definitions suggest, the money market and capital market have different time frames. First of all, money markets consist of short-term transactions of Certificates of Deposits, commercial paper, and treasury. Besides, the time period for these exchanges is usually equal to or less than 1 year.

On the other hand, capital markets involve trading of capital market tools for a period between 3 years and 10 years, or even longer. As a result, capital markets fulfil the medium and long-term capital goals of corporations.

·       Market Instruments – Money and capital market instruments have different timelines for maturity. On one hand, money market instruments like CDs, CPs, BAs, and Repurchase Agreement are valid for a period between 1 day and 1 year. As a result, their liquidity factor is significant for corporations to fund their short-term capital requirements.

Contrarily, capital market instruments like shares, bonds, and debentures have a lower degree of liquidity. They contribute to long-term capital needs and are prone to changes in financial value as per appreciation and depreciation.

·       Risk Element – Money markets exhibit lower levels of financial risk because the trading of short-term assets is done within a short period of time. Therefore, money market instruments benefit corporations immensely due to their ability to withstand market risks. Additionally, these instruments are liquid, and thus can be traded in the market to minimise risks.

On the other hand, capital markets experience higher risk levels since they have a much longer period of maturity. As a result, these have an enhanced elasticity towards market and financial trends.

Another essential point of money market and capital market difference is that the former offers a comparatively lower rate of return on investment. Whereas, the rate of return on investment in capital markets is higher due to the long time period involved.

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Frequently Asked Questions

1.  What is the Money Market?

Ans. – Money market is the part of financial markets that deals with short-term debt instruments such as liquid cash, commercial paper, Certificates of Deposit, and Banker’s Agreement.

2.  What is the Capital Market?

Ans. – Capital market is the section of financial markets that facilitates the trade of long-term debt securities such as stocks, shares, debentures, and bonds. 

3.  What is the Difference Between Money Market and Capital Market?

Ans. – The fundamental difference between money market and capital market is their timeline for maturity. Money markets deal with short-term debt instruments such as money, CDs, CPs, and Bas. On the other hand, capital markets deal with long-term securities such as shares, bonds, and debentures.