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Difference Between Money Market and Capital Market

Updated on May 27, 2024
Article byWallstreetmojo Team
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

Money Market vs Capital Market

The money market and the capital market are the two different types of financial markets wherein the money market is used for short-term borrowing and lending. In contrast, the capital market is used for long-term assets, i.e., assets which have a maturity of more than one year.

The money market and capital market are types of financial markets. Money markets are used for short-term lending or borrowing; usually, the assets are held for one year or less, whereas capital markets are used for long-term securities. They have a direct or indirect impact on the capital. Capital markets include the equity market and the debt market.

What is the Money Market?

Money markets are unorganized markets where banks, financial institutions, money dealers, and brokers trade in financial instruments quickly. For example, they trade in short-term debt instruments like trade credit, commercial paper, certificate of deposit, T bills, etc. They are highly liquid and can be redeemed in less than 1.

Trading in the money market is done mostly through over-the-counter (OTC), i.e., no or little use of exchanges. However, they provide businesses with short-term credit and play a major role in providing liquidity in the economy over the short term. In addition, it helps the business and industries with working capital requirements.

Money-Market-and-Capital-Market Differences

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What is Capital Market?

The capital market is a type of financial market where financial products like stocks, bonds, debentures are traded for a long time. They serve the purpose of long-term financing and long-term capital requirement. The capital market is a dealer and an auction market and consists of two categories:

  • Primary market: A primary market where the fresh issue of securities is offered to the public.
  • Secondary market: A secondary market where securities are traded between the investors.

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Video Explanation of Money Market and Capital Market

Money Market vs Capital Market Infographics

Money-Market-and-Capital-Market Infographics

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Key Differences

  • Short-term securities are traded in money markets, whereas long-term securities are traded in capital markets.
  • Capital markets are well organized, whereas money markets are not that organized.
  • Liquidity is high in the money market, whereas liquidity is comparatively low in capital markets.
  • Due to high liquidity and low maturity duration in money markets, instruments in money markets are a low risk, whereas capital markets are comparatively high risk.
  • A central bank, commercial banks and non-financial institutions majorly work in money markets, whereas stock exchanges, commercial banks, and non-banking institutions work in capital markets.
  • Money markets are required to fulfill the capital needs in the short term, especially the working capital requirements. Capital markets are required to provide long-term financing and a fixed capital for purchasing land, property, machinery, building, etc.
  • Money markets provide liquidity in the economy where capital markets stabilize the economy due to long-term financing and savings mobilization.
  • Capital markets generally give higher returns, whereas money markets give a low return on investments.

Comparative Table

Basis for ComparisonMoney MarketCapital Market
DefinitionIt is the part of financial market where lending and borrowing takes place for short-term up to one yearCapital market is part of the financial market where lending and borrowing takes place for the medium-term and long-term
Types of instruments involvedMoney markets generally deal in promissory notesbills of exchange, commercial paper, T bills, call money, etc.Capital market deals in equity shares, debentures, bonds, preference shares, etc.
Institutions involved/types of investorsThe money market contains financial banks, the central bank, commercial banks, financial companies, chit funds, etc.It involves stockbrokers, mutual funds, underwriters, individual investors, commercial banks, stock exchanges, Insurance Companies
Nature of MarketMoney markets are informalCapital markets are more formal
Liquidity of the marketMoney markets are liquidCapital Markets are comparatively less liquid
Maturity periodThe maturity of financial instruments is generally up to 1 yearThe maturity of capital markets instruments is longer and they do not have stipulated time frame
Risk factorSince the market is liquid and the maturity is less than one year, Risk involved is lowDue to less liquid nature and long maturity, the risk is comparatively high
PurposeThe market fulfills the short-term credit needs of the businessThe capital market fulfills the long-term credit needs of the business
Functional meritThe money markets increase the liquidity of funds in the economyThe capital market stabilizes the economy due to long-term savings
Return on investmentThe return in money markets are usually lowThe returns in capital markets are high because of higher duration

Conclusion

  • Both are part of the financial markets. The main aim of the financial markets is to channel funds and generate returns. The financial markets stabilize the money supply by lending borrowing mechanism, i.e., surplus funds are provided to borrowers by the lenders.
  • Both are required for the betterment of the economy as they fulfill the business and industry’s long-term and short-term capital needs. The markets encourage individuals to invest money to gain good returns.
  • Investors can tap into each of the markets depending on their needs. Capital markets are generally less liquid but provide good returns at higher risk, whereas money markets are highly liquid but provide lower returns. Money markets are also considered safe assets.
  • However, market anomalies and inefficiency due to some aberrations above may not hold. Due to such irregularities, investors look for arbitrage opportunities to get higher returns. Money markets are considered safe, but they sometimes give negative returns. Thus, investors should study the pros and cons of each financial instrument and the condition of the financial market before putting their money for the short term or long term.

This has been a guide to Money Market vs Capital Market. Here we discuss the top differences between the money market and the capital market with infographics and comparison table. You may also have a look at the following articles –

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