Difference Between Money Market and Capital Market
Both money market and capital market are meant for investment. However, the two marketplaces differ in terms of time period of lock-in, investment and maturity. These two also have different foundational reasons behind their existence.
In this article, we will discuss the difference between money market and capital market. We will also learn about what these financial markets are about and what they offer.
Table of Contents
- Difference between money market and capital market
- What is money market?
- Instruments used in money market
- Advantages of money market
- What is capital market?
- Instruments used in capital market
- Advantages of capital market
Difference Between Money Market and Capital Market
Let us understand the difference between money market and capital market based on different parameters.
| Parameter | Money Market | Capital Market |
| Debt type | Short term | Long term |
| Risk | Low | High |
| Liquidity | High | Low |
| Purpose | Increasing liquidity | Stabilizing economy |
| ROI | Low | High |
| Maturity Period | Up to 1 year | More than 1 year |
| Organized | Informal | Regulated |
What is Money Market?
The money market is a part of financial markets where instruments with high liquidity and short-term maturities are traded. Short-term securities with a maturity period of one year or less are traded in the money market. The trading process in this market is a wholesale process where over-the-counter trading takes place for borrowing and lending for a short term. This part of the financial market is one of the best places for investing in liquid assets. Financial institutions and dealers that want to borrow and loan securities participate in this market.
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Instruments traded in Money Market
A variety of financial instruments are traded in the money market in stock exchanges. The interest rate of these instruments is controlled and monitored by the RBI. These include the following:
- Banker’s acceptance(BA): It is a negotiable piece of paper with similar functionality as a post-dated cheque. In the case of a BA, the bank guarantees payment instead of the account holder. These are also known as ‘bills of exchange’.
- Treasury bills (T-bills): T bills are short-term debt instruments presented in three tenors of 91, 182 and 364 days. These are zero coupon securities issued at a discount and redeemed at face value of maturity. T-bills do not pay any interest to investors.
- Bonds: These are debt instruments in which investors loan money to entities at a fixed or variable interest rate at a defined period. Public and private organizations use bonds to finance their business activities.
- Certificate of deposit (CD): This savings account holds a fixed amount of money for a fixed period. In exchange, the issuing bank pays principal with interest whenever you cash in or redeem your CD.
- Commercial paper: Commercial Paper is an unsecured short-term debt instrument issued by corporations to finance their short-term liabilities. CP is issued at a discount from the face value in which a specific amount of money has to be repaid by a specific date. Usually, the term of maturity extends from 1-270 days.
- Repurchase agreements: Repo is a short-term borrowing in government securities. Dealers sell government securities to investors on an overnight basis. They then buy them back at a slightly higher price. This price difference is the implicit overnight interest rate.
Read in detail Instruments of Money Market
Advantages of Investing in Money Market
Money market is a safe place for investment which has the following advantages:
- Providing borrowers with short-term funds at a reasonable price.
- Allowing lenders to turn their idle funds into effective investments.
- Regulating the liquidity level in the economy.
- Helping organizations gain required funds for working capital requirements.
- Offering banks the opportunity to park their surplus funds.
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What is Capital Market?
It is a long-term debt financial market where investment is made in securities with a lock-in period of more than one year. It is a source of raising funds for firms, governments, and individuals. Major financial institutions and big companies are the suppliers of funds in this market. There are two main capital markets: primary market and secondary market.
Capital market functions on the theory of circular flow of money. In this market, money from households and individual investors is invested in the bonds and shares of a firm. The investors earn profits as well.
Related Read – Features of Money Markets
Instruments traded in Capital Market
The following financial instruments are traded in the capital market with the mindset of long-term investment.
- Shares: These represent units of equity ownership within a company. Investors with shares are known as shareholders who hold a part of the company until they have this security. Investors can earn profits through trading as well as dividends.
- Debentures: An unsecured long-term debt instrument is useful for companies that do not want to dilute their equity. Only interest is paid during the loan period, and the full principal is repaid when the debenture matures.
- Government securities: These are tradable debt securities that central or state governments issue to fund their operations. These are both short-term and long term. Whenever a person buys government securities, that person becomes a creditor since he/she is lending money to the government. The process of G-Sec changes due to various economic factors.
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Advantages of Investing in Capital Market
Investors prefer investing in capital market for the following reasons:
- Allows businesses to raise capital for their operations.
- Eases trade execution on trading platforms as per the convenience of investors.
- Maximizes returns on investment with investment in high-interest-yielding securities such as stocks.
- Provides secure trading space for investors as SEBI regulates it.
- It broadens your investment portfolio as it offers investment in various securities.
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Conclusion
Hope that this article has been able to help you understand the difference between money market and capital market. As an investor, it is important to understand your requirements, risk capacity, and tolerance. Based on the analysis, one must thoroughly research how these two markets function. Investors then need to decide the marketplace that suits their needs.
FAQs
How do Money Market and Capital Market differ?
The primary difference between the Money Market and the Capital Market lies in the maturity period of the securities traded. The Money Market deals with short-term securities that mature in less than one year, focusing on liquidity and safety. In contrast, the Capital Market involves longer-term securities that have a maturity period of more than one year, focusing on generating higher returns.
Who are the participants in the money market?
Participants of the money market include banks, financial institutions, governments, corporations, and individual investors. These entities either need to park their short-term excess funds or require short-term borrowing to manage their liquidity positions.
Who are the participants in the capital market?
The participants of the Capital Market include companies issuing stocks or bonds, investors buying these securities, governments issuing bonds, investment banks, brokerage firms, and institutional investors like pension funds and mutual funds.
What are the objectives of investing in the money market?
The objectives of investing in the Money Market include ensuring liquidity, safeguarding capital, and earning a stable but relatively low rate of return. It is preferred by investors who seek short-term, low-risk investment options.
What are the objectives of investing in the Capital Market?
Investing in the Capital Market aims to achieve higher returns for the long term through capital appreciation and dividends. Investors in the capital market are interested in accepting higher risks for the potential of greater rewards.
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