The financial systems of a country comprised of four different types of financial markets viz Money Market, Capital Market, Commodity Market and Forex Market. Each market deals with separate financial instruments and fulfil different types of credit requirements of businesses.
The corporates or government meet their short term or long term needs of funds by raising funds from the general public through these financial markets.
In this article, we will focus on money market and capital market. we will further discuss the difference between money market and capital market as well.
Table of Contents
Money Market and Capital Market:
Although both the money market and capital market are the market place which facilitates the businesses or government in raising funds from the general investors and where the various financial securities are traded among different investors. Let us first understand what does it meant by money market and capital market.
Money Market refers to the market place where the financial instruments having a short term (less than one year) maturity period are traded or sold to the investors.
In other words, the money market is the marketplace through which the companies or government entities or other financial institutions meet their short term credit requirements. If the companies need capital for a short term period, they issue securities with short term maturity period in the money market.
Hence Money market deal with short term financial securities such as Treasury bills, commercial papers, certificate of deposits, bill of exchange, Repo (Repurchase agreement) etc. The money market is highly liquid in nature and hence carry less risk.
On the other hand, the capital market refers to the marketplace which caters long term credit requirements of the companies as well as government entities and where the long term (more than one year) securities such as equity shares, debentures, government or corporate bonds or preference shares are issued and traded among investors.
The capital market is further classified into primary market and secondary market. The primary market deals with new issues of long term securities, however, in the secondary market these securities are traded among different investors.
Money Market vs Capital Market (Comparison Table):
| BASIS OF COMPARISON | MONEY MARKET | CAPITAL MARKET |
|---|---|---|
| Meaning & Definition | Money Market refers to the market place where the financial instruments having a short term (less than one year) maturity period are traded or sold to the investors. | Capital market refers to the marketplace which caters long term credit requirements of the companies as well as government entities and where the long term (more than one year) securities are issued and traded. |
| Instruments | Treasury bills (T-Bills), commercial papers, certificate of deposit, promissory notes, bill of exchange, repurchase agreements (Repo), line of credit, bankers' acceptance etc | Government or corporate bonds, equity and preferred stocks, debentures etc |
| Participants | Commercial banks, Central bank, primary dealers, mutual funds and other financial institutions. | Stockbrokers, insurance companies, mutual funds companies, stock exchanges merchant and investment bankers, and other individual or institutional investors |
| Liquidity | High | Less |
| Risk Involved | Less | More |
| Returns | Low | High |
| Purpose | Caters short term credits of companies, government and other financial institutions. | Caters long term credits of companies, government and other financial institutions. |
| Functional Merit | Enhances the supply of money (liquidity) in the economy. | Stabilizes the economy due to stable and long term investments. |
Difference between Money Market and Capital Market:
Now let us understand the key difference between money market and capital market. The money market and capital market can be distinguished based on various aspects as follows.
Meaning & Definition:
As we discussed above, in the money market, the financial instruments with less than one year of maturity period are issued and traded whereas in the capital market financial securities having the maturity period more than a year are issued and traded among investors.
Instruments:
The Treasury bills (T-Bills), commercial papers, certificate of deposit, promissory notes, bill of exchange, repurchase agreements (Repo), line of credit, bankers’ acceptance etc are some examples of money market instruments, on the other hand, government or corporate bonds, equity and preferred stocks, debentures etc are the examples of capital market instruments.
Participants:
Typically, commercial banks, Central bank, primary dealers, mutual funds and other financial institutions are main participants in the money market whereas stockbrokers, insurance companies, mutual funds companies, stock exchanges merchant and investment bankers, and other individual or institutional investors are major participants of the capital market.
Liquidity:
The money market provides high liquidity as it deals with the short term financial securities, on the other hand, the capital market caters medium or long term securities, hence comparatively less liquid market.
Risk Involved:
As the money market is a highly liquid market place, therefore when it comes to the risk factor, it is a less risky market, on the other hand, as the capital market deal with long term securities which includes equity shares/stocks whose price is determined by the stock market (demand & supply), hence it is riskier than the money market. However, bonds or debentures being debt instruments, provide guaranteed returns as well.
Returns on Investment:
As the money market is associated with short term financial securities, this means investors mobilize their funds for a short duration, therefore, the return on investment is also less, however, in the capital market, funds are parked for a longer duration by the investors, hence, returns are also higher than the money market.
Purpose:
Money market fulfils short term credits of corporates and other financial institutions and enhances the supply of money (liquidity) in the economy, while the capital market caters long term capital requirement of the corporations and stabilizes the economy due to stable and long term investments.
Conclusion:
Money market and capital market both are equally important components of the financial system, however, their role is slightly different from each other. In a nutshell, we can conclude that money market provides liquidity, less risk, less return and functions to provide short term credits whereas capital market offers comparatively less liquidity, relatively less risk and high returns.
Related Articles:
Difference between Primary market and Secondary Market
Merchant Banking and Investment Banking
References:
1) Investopedia
