- Money Market: Focuses on short-term, highly liquid investments with low risk.
- Capital Market: Deals with long-term investments like stocks and bonds, offering higher returns but higher risk.
- Instruments of the money market use Treasury bills and CDs; capital markets include stocks, bonds, and ETFs.
- Liquidity of the money market is highly liquid; the capital market has comparatively lower liquidity.
- Purpose of the money market addresses immediate funding needs; the capital market supports long-term growth and expansion.
A market is a place where buyers and sellers gather to complete transactions. Just as we shop for everyday items in markets, financial assets are traded in specialized financial markets. In India, there are two primary types of financial markets: the money market and the capital market. These platforms facilitate the exchange of financial instruments. Let’s understand it in more detail.
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Difference Between Money Market and Capital Market
Following are a few major difference between money market and capital market:
| Basis | Money Market | Capital Market |
|---|---|---|
| Meaning | A financial market having a group of financial institutions trades short-term financial instruments, for typically less than a year. | The capital market is a financial market where companies and governments issue and trade securities to raise long-term funds needed for their capital requirements. |
| Instruments | Treasury bill, CD, Bill of exchange, call money etc | Bonds, derivatives, ETFs etc |
| Investors | Central and commercial banks, non financial institutions and others. | Commercial banks, companies, government etc. |
| Market liquidity | Highly liquid | Comparatively less liquid |
| Risk rate | The risk is considered low here | Capital market has high risk rate |
| Maturity period | Maximum maturity period is 1 year | Longer time period than one year, |
| Purpose | The purpose is to meet short-term financial requirements. | It helps in achieving long term capital requirements. |
| ROI | ROI is usually low in money market | Comparatively, the ROI is higher in the capital market. |
| Market nature | Informal | Formal & highly regulated |
| Transaction mode | Over the counter (OTC) | Exchange |
| Further category | None | Two categories: Primary and secondary |
What is the Money Market?
The money market encompasses financial instruments that assist companies in raising funds for short periods, typically less than one year. It addresses immediate funding needs and facilitates the movement of funds across various sectors. In this market, cash flows continuously between the government, banks, corporations, and financial institutions.
Additionally, interbank lending is a common practice in the money market. Banks often lend funds to each other using financial instruments such as Treasury bills, commercial paper, certificates of deposit, trade credit, and collateralized loans. The trading of these instruments is done on Over the Counter (OTC) and exchanges.
If someone wishes to park their cash for a short period of time, the money market is considered to be the best option.
Purpose: Money market provides funds to businesses and governments who need cash to carry out operations. Funds are provided on modest returns and low risks.
What are the Features of Money Market?
- Maturity period of the money market is up to 1 year.
- Trades in highly liquid assets which means the assets that can be converted into cash easily.
- All transactions are done digitally without the requirement or a broker.
- Money market components include: Central and commercial banks, Non-banking financial companies, government etc.
What Are Money Market Instruments?
Following are the 5 types of money market:
- Call Money: It is a short term loan that can and its maturity starts from 1 day and goes up till 14 days. Call money can be repaid at demand.
- Treasury Bill: It is an instrument issued by RBI on behalf of the government. It acts as a promissory note which helps the government in meeting short term financial needs.
- Ready Forward Contract (Repo): It refers to sale and repurchase of an agreement between 2 parties. In India, a repo is prepared between various banks and between banks and RBI as well.
- Interest Rate Swaps: It refers to a contact between 2 parties in order to exchange interest rates. Under the IRS, one party decides to pay fixed interest rates and the other party pays floating interest rates.
- Certificate of Deposit (CD): It refers to a type of a savings account offered by banks. The investor invests a particular amount for a fixed time period and banks pay interest on that investment.
- Bill of Exchange: These are promissory notes issued by companies to meet their short-term financial obligations.
What are the Advantages of Investing in the Money Market?
Below are a few advantages of investing in money market:
- The instruments of a money market can be converted into cash easily, making them highly liquid.
- These instruments are considered safer as investment risk is very low.
- Instruments like Certificate of Deposit (CD) of money markets ensure fixed and stable interest rates.
- It is easy to acquire money market instruments. Investments can be made through banks etc.
What is the Capital Market?
The capital market is designed for long-term investments with maturities extending beyond one year. In this market, financial assets such as stocks, bonds, exchange-traded funds (ETFs), mutual funds, and other investment instruments are traded. While it offers the potential for significant returns over the long term, it also comes with higher risk compared to the money market. The capital market is closely monitored and analyzed to gauge the overall health of the economy. Its movements provide insights into industry performance and future economic trends.
Purpose: Companies and corporations utilize capital market instruments to raise funds for long-term projects, generate substantial revenue, and drive business growth through strategic investments.
The capital market is further divided into two types of market:
- Primary market: Here, a new issuance of financial assets like stocks and bonds are offered to investors. For example: IPO
- Secondary market: Here, the securities that are already issued once are traded amongst investors. The issuer may or may not be involved in the trade.
What are the Features of Capital Market?
- Allows long-term investments, typically more than 1 year.
- Capital market provides higher returns and deals in both commercial and noncommercial securities.
- Regulated by authorities for a transparent cash flow.
- Used by companies for long term gains
- This market has multiple participants including foreign investors. Agents are required here.
What are the Examples of Capital Market Instruments?
Following are a few examples of the capital markets:
- Equities: It refers to the shares of ownership in any company. Know Equity Funds – Meaning & its Types
- Stock Exchanges: Platforms like the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) where stocks are traded.
- Bonds: Businesses and governments gain capital for the long term through these debt securities. Check everything you should know about bonds.
- Derivatives: The contract that derives their value through the performance of an underlying index, rate or asset.
- Exchange-Traded Funds (ETFs): Investment funds traded on stock exchanges, representing a collection of assets.
- Foreign Exchange Instruments: It refers to a contract used for exchange of one currency to another.
What are the Advantages of Investing in Capital Market?
- Capital market opens the doors for maximized returns by investing in instruments like stocks
- Being a highly regulated market, capital markets are considered secure and transparent when it comes to long-term investments.
- Investors can get a steady cash flow through several dividend paying instruments of this market.
- A diversified portfolio can be created through a wide range of investment options
- By investing in various instruments, the investor can spread the overall investment risk.
Are the Alternatives to Money and Capital Market?
Beyond the money market and capital market, there are other investment instruments which can help you in diversifying your portfolio.
- Real estate
- Gold & other precious metals
- Fixed-income assets such as FDs
- Collectables including coins, artworks etc.
The money market handles short-term funding needs with instruments like Treasury bills and certificates of deposit, focusing on liquidity and low risk. In contrast, the capital market facilitates long-term investments through stocks, bonds, and ETFs, offering higher returns and greater risk. Each market serves distinct purposes, with the money market providing immediate cash flow and the capital market supporting growth and expansion. It is important to evaluate the advantages of both the markets before investing.
