Wealth is something that must be carefully managed. The primary two ways this is achieved is by either growing your existing wealth or maintaining what you already have. It isn’t very clear to choose between these two different paths. This is where the two different types of the market come in. In the world of finance, there are two primary types of market: capital market and money market. These financial markets are two very large components of the global financial market. The funds invested into these markets can either be used in the short term for lending and borrowing or even in the long term.
Money Market
The money market involves trading – both lending and borrowing – in short-term debt. There is a constant flow of cash between governments, banks, financial institutions, and corporations in this market. The lending and borrowing done here are for a short-term period – it can be as short as overnight but no longer than one year. When institutions want to park their cash for a short period, this is the way to go. Governments and businesses that need cash to operate can retrieve it at reasonable costs. The money market is also useful when businesses have more cash than needed and want some use for it.
This market has low risks and low returns. Instruments used for trading include Treasury Bills, commercial paper, certificate of deposit, trade credit, collateral loan, etc. All of them are liquid and can be redeemed within a year. Trading between two parties is done Over the Counter (OTC) and involves few exchanges.
Types of Money market
Organized Segment: The Organized Money market operates under strict and complex rules. Great control is exercised over them. Participants in the organized money market segment include:
- Banks
- Co-operative Societies
- NBC’s, etc.
Unorganized Segment: This segment is used by those borrowers who cannot get credit from the organized segment. This segment is much more flexible. Borrowers get higher interest rates and undergo informal procedures. Participants in the unorganized money market segment include:
Money Lenders
Chit Fund Company, etc.
Capital Market
Unlike the Money market, the Capital market involves trading in bonds, stocks, and debentures, in the long term. This market involves companies issuing bonds and stocks to raise money to grow their businesses. Investors buy these stocks to share in the company’s growth and gain more money. The maturity period in the capital market is greater than one year.The capital market aids in long-term capital investment and long-term financing. Companies and corporations that enter the capital market do so to raise money. This money is then put toward increasing their revenue and expanding their business. The capital market comes with higher returns but also higher risks.
Changes and movements in the capital market are closely monitored hourly. These shifts are then analyzed for clues to better understand the status of the participating industries, the health of the wide-scale economy, and how the future appears. In other words, the capital market is a dealer with an auction market.
Types of Capital Market
Primary Market: The Primary Market, also known as the IPO market, is where companies issue new bonds and stocks for sale to institutions and investors. Further capital may also be issued by companies whose shares are already listed. Many intermediaries operate in this market to assist in transactions. Some of them are:
- Bankers
- Brokers
- Portfolio Manager, etc.
Secondary Market: The Secondary Market is where the issued securities from the Primary Market are traded. Here, instead of purchasing security from the source (issuer), it is bought from another investor. Although the original issuer of the bond or stock does not benefit directly from the resale, this does potentially help them raise the price of their stock shares over time.
Differences between Money Market and Capital Market
Basis for Comparison | Money market | Capital market |
Definition | The part of the financial market where borrowing and lending are done in the short term. | The part of the financial market where borrowing and lending are done in the long term. |
Types of instruments involved | Treasury bills, commercial paper, trade credit, certificate of deposit, etc. | Bonds, debentures, preference shares, equity shares, and more. |
Nature of Market | Informal | Formal |
Liquidity of the Market | Very liquid | Not very liquid |
Maturation period | Up to a year. | More than a year. However, there is no fixed time frame. |
Types of investors/institutions | Commercial banks, financial banks, companies, central banks, chit funds, etc. | Individual investors, commercial banks, underwriters, mutual funds, stockbrokers, etc. |
Purpose | Fulfills the short-term credit needs of companies and businesses. | Fulfills the long-term credit needs of companies and businesses. |
Risk Factor | Low risk. | High risk. |
Return on investment | Low. | High. |
Functional Merit | The liquidity of funds in the economy is increased. | Long-term savings help stabilize the economy. |
Conclusion
The Money market and the Capital market are critical elements of the financial market at large. Both are required for the betterment of the economy and to fulfill companies’ needs, be it short-term or long-term. Depending on what their needs are, businesses tap into the markets accordingly.With the help of these markets, funds are channelized from lenders to borrowers. Before investing in either of the markets, it is important to study the condition of the financial market, analyze their needs, and the pros and cons of each financial instrument.
