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 marketMoney MarketThe money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders. 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.
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What is the Money Market?
Money markets are unorganized markets where banks, financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. , 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 depositCertificate Of DepositA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period., 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-counterOver The CounterOver the counter (OTC) is the process of stock trading for the companies that don't hold a place on formal exchange listings. The broker-dealer network facilitates such decentralized trading of derivatives, equity and debt instruments. (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 capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)" requirements.
What is Capital Market?
The capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets. 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 financingLong-term FinancingLong term financing means financing by loan or borrowing for a term of more than one year by way of issuing equity shares, by the form of debt financing, by long term loans, leases or bonds, done for usually extensive projects financing and expansion of the company. and long-term capital requirement. The capital market is a dealer and an auction marketAn Auction MarketAuction Market is a marketplace where the buyers and sellers trade stock by bidding. The price is calculated based on the highest amount a buyer is ready to pay and the lowest amount a seller is ready to accept. and consists of two categories:
- Primary market: A primary marketPrimary MarketThe primary market is where debt-based, equity-based or any other asset-based securities are created, underwritten and sold off to investors. It is a part of the capital market where new securities are created and directly purchased by the issuer. where the fresh issue of securities is offered to the public.
- Secondary market: A secondary marketSecondary MarketA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them. where securities are traded between the investors.
Video Explanation of Money Market and Capital Market
Money Market vs Capital Market Infographics
- 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 banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits. 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 capitalFixed CapitalFixed capital refers to the investment made by the business for acquiring long term assets. These long term assets don’t directly produce anything but help the company with long-term benefits. for purchasing land, property, machinery, building, etc.
- Money markets provide liquidityProvide LiquidityLiquidity is the ease of converting assets or securities into cash. 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.
|Basis for Comparison
|It is the part of financial market where lending and borrowing takes place for short-term up to one year
|Capital market is part of the financial market where lending and borrowing takes place for the medium-term and long-term
|Types of instruments involved
|Money markets generally deal in promissory notesPromissory NotesA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date., bills of exchangeBills Of ExchangeBills of exchange are negotiable instruments that contain an order to pay a certain amount to a particular person within a stipulated period of time. The bill of exchange is issued by the creditor to the debtor when the debtor owes money for goods or services., commercial paper, T bills, call money, etc.
|Capital market deals in equity shares, debentures, bonds, preference sharesPreference SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation., etc.
|Institutions involved/types of investors
|The 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 exchangesStock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ., Insurance Companies
|Nature of Market
|Money markets are informal
|Capital markets are more formal
|Liquidity of the market
|Money markets are liquid
|Capital Markets are comparatively less liquid
|The maturity of financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes. is generally up to 1 year
|The maturity of capital markets instruments is longer and they do not have stipulated time frame
|Since the market is liquid and the maturity is less than one year, Risk involved is low
|Due to less liquid nature and long maturity, the risk is comparatively high
|The market fulfills the short-term credit needs of the business
|The capital market fulfills the long-term credit needs of the business
|The money markets increase the liquidity of funds in the economy
|The capital market stabilizes the economy due to long-term savings
|Return on investment
|The return in money markets are usually low
|The returns in capital markets are high because of higher duration
- 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 –