A place where buyers and sellers meet to trade goods and services is called a market. Similarly, the financial market is a place that enables buyers and sellers to trade financial assets. The two key financial markets are the capital market and the money market.
This article talks about what the capital market is, the types of the capital market, capital market instruments, what the money market is, various types of money market instruments and the differences between the money market and capital market.
What Is The Capital Market?
The capital market is a financial market where buyers and sellers trade long-term financial assets. Such financial assets either may not have a specific maturity period or have a long maturity period, at least more than a year.
Understanding The Capital Market
The capital market enables the government, financial institutions, companies, etc., to raise the required long-term funds by issuing capital market instruments like shares, bonds, debentures, etc. Investors, in return, get moderate to high returns.
One of the key functions of the Indian capital market is that it promotes savings habits and helps to channel them into productive investments. Thus, it connects investors and borrowers and fulfills the needs of both.
Types Of The Capital Markets
Primary market
The primary market is a marketplace where securities are first issued. For instance, if a company comes with an initial public offering (IPO), it is said to raise funds from the primary market.
Secondary market
The secondary market is where the already existing securities are traded among the investors. For instance, if you buy any stock from another investor through the stock exchange, that transaction is said to have occurred in the secondary market.
Capital Market Instruments
Here are the types of capital market instruments.
Equity securities
Equity securities represent partial ownership in an issuing company. Mainly, there are two types of equity securities – common shares and preference shares. As a common shareholder, you can have voting rights. On the other hand, as a preferred shareholder, you may get preferred over equity shareholders in terms of dividend payment and assets in the event of bankruptcy.
If you own these shares, you may earn from dividend income and capital growth. Equity shares may not have specific maturity; however, holding them for the long term might give you good returns.
Debt securities
Bonds and debentures are those financial instruments by which companies, governments or other financial institutions borrow money from investors for a specific period. At the end of that period, they repay the amount to the borrowers.
Example Of The Capital Market
A company, willing to expand its operations, came with an initial public offering (IPO) to raise funds from the primary market. Post-IPO, its shares have been trading in the secondary market, i.e. on the stock exchanges, and investors can buy and sell the shares from there.
What Is The Money Market?
The money market is a financial market where buyers and sellers trade short-term financial assets. These financial assets have a maturity period somewhere between overnight to a year.
Understanding The Money Market
The money market helps fulfil the short-term fund requirements of the government, financial institutions, companies, etc. Plus, it lets the investors earn some returns by parking their funds for the short term.
One of the prominent features of the money market is high liquidity because various money market instruments allow you to cash out your investments within a year. Moreover, the money market usually has a large volume of transactions.
Types Of Money Market Instruments
Here are various types of money market instruments.
Certificate of deposit
Commercial banks and some financial institutions may issue a certificate of deposit. It may be issued in the denomination of ₹5 lakh and multiples thereof and with a maturity period between seven days to one year (from the date of issue).
Commercial paper
Corporates, primary dealers and some financial institutions may issue commercial paper to borrow short-term funds. It may also be issued in the denomination of ₹5 lakh and multiples thereof. It may have a maturity period between seven days to one year (from the date of issue).
Treasury bills
Treasury bills, also called T-bills, are issued by the central government of a country. They may not offer coupon payments. Instead, they may be issued at a discount and repaid at par. T-bills may have different tenures, such as 14-day, 91-day, 182-day and 364-day. They are issued in the denomination of ₹25,000 and multiples thereof.
Repurchase agreements
A repurchase agreement or repo is helpful to government securities dealers for short-term borrowing. There may be term repo and open repo, where term repo has a fixed maturity date, and open repo does not.
Example Of The Money Market
A company issues commercial papers of ₹5,00,000 with a tenure of 15 days to meet its working capital requirements. Here, the investors can buy one unit of commercial paper for ₹5,00,000 or more for multiples of ₹5,00,000.
Money Market Vs Capital Market: Key Differences
Here are the top 8 differences between the money market and capital market.
| Point of difference | Money market | Capital market |
| Purpose | To meet borrowers’ short-term fund requirements | To meet borrowers’ medium and long-term fund requirements |
| Participants | Central banks, commercial banks, mutual funds, financial institutions, individual investors etc. | Companies, stock exchanges, mutual funds, underwriters, stock brokers, retail investors, etc. |
| Instruments | Treasury bills, commercial papers, repurchase agreements, certificates of deposits, etc. | Equity shares, preference shares, debentures, bonds, etc. |
| Liquidity of financial instruments | Highly liquid. | Relatively less liquid. |
| The maturity period of financial instruments | One year or less. | Could be more than a year. |
| Risk factor | Relatively less risky because of its short duration. | May involve more risk because of long-term maturity. |
| Return on investments | Expected returns may be lower. | Expected returns may be higher. |
| Relevance to the economy | Brings and boosts liquidity in the economy. | Mobilise savings and convert them into productive investments. |
Conclusion
Money markets and capital markets meet the capital needs of borrowers for different time lengths. While various money market instruments provide higher liquidity, they may offer relatively lower returns. In comparison, capital market instruments may offer good returns but might be riskier. Before investing in any instrument, it is better to check all its important aspects.
At WealthDesk, we make it possible for you to invest in WealthBaskets, which are combinations of equities and ETFs that reflect an idea, theme, or strategy. SEBI registered professionals build WealthBaskets.
FAQs
Since the financial instruments in the money market usually have high liquidity and a small maturity duration, they might be less risky. Therefore, the money market is probably less risky compared to the capital market.
The capital market plays a crucial role in bringing together those who need the funds and those who have excess funds. Thus, it helps in mobilising savings and converting them into productive investments.
The central governments and corporations may issue securities in the money market to obtain short-term funds. Investors looking to park funds for the short-term, to gain some returns, may invest in money market instruments.
