Concept of Money Market and Capital Market

Financial Market

The financial system is the important element of an economy. Financial resources are exchanged through the financial system. Financial market is the heart of the financial system. Financial market is the mechanism through which financial instruments are being traded. The financial market is said to be the brain of entire economic system. The savings are channeled to investments through financial markets. The financial instruments like stocks, bonds, insurance policy, government securities, and debentures are being traded in the financial market.

According to S.K. Cooper and other “Financial markets are the markets in which financial instruments are traded“.

Similarly, according to Dudley G. Luckett, “Financial market is to be understood as any exchange of a variety of financial instruments“.
The financial market is said to the ‘brain’ of entire economic system. The savings are channeled to investments through financial market. The financial instruments like stock, bond, insurance policy, government securities and debentures are traded in the financial market.

The two important types of financial market are capital market and money market.

Capital Market and Money Market

The capital Market and Money Market are two types of Financial Markets. The primary difference between the two is that if the organizations have to borrow or invest funds for a longer period of time, they go in the Capital Markets  and if they want to borrow or invest funds for a shorter period, say less than one year, they go for the money markets. Secondly, capital market deals with the stocks and bonds, whereas money market deals with the certificates of deposits, bankers’ acceptance, repurchase agreements and commercial paper. Thirdly there are high speculations in capital markets than in money markets because capital market offers high maturity period to credit instruments. Moreover, higher of returns are  paid on the securities traded in capital market as compared to the money market because of high risks associated with the capital market instruments with higher maturity period.

What is capital market?

The market dealing in long term finance is known as capital market. This market makes funds available for long term investment. Hence, capital market is the market for long term credit.

Capital Markets are the markets for the intermediate- or long term debt and corporate stocks. The New York stock exchange, where the stocks of the largest U.S. corporations are traded, is a prime example of a capital Market.

According to Dudley G. Luckett, “A capital market is just what the name implies: a market for capital funds. Strictly speaking, the capital market encompasses any transaction involving long term debt or equity obligations.”

In the words of S.K. Cooper and others, “ The framework for lending and borrowing of funds for period longer than one year is called the capital market.”

The world Bank defines capital market as, “ The market in which long term instruments such as equities and bonds are raised and traded.”

Capital market is one of the significant aspects of financial market. Broadly speaking, the capital market is the market for financial assets, which have a long or indefinite maturity. Unlike money market instruments with maturity not exceeding one year, capital market instruments have maturity of above one year. It is an institutional arrangement for lending and borrowing money for a longer period of time. Capital market involves various instruments which can be used for financial transactions. Capital market provides long term debt and equity finance for government and corporate sector. The capital market can be classified into primary and secondary market. The primary market is the market for new issues, whereas in secondary market existing securities are traded. Capital market institutions provide rupee loans, foreign exchange loans, consultancy services and underwriting.

Basically capital market is a type of financial market, it also includes  the stock and bond markets as well. But in general capital market is the market  for securities where either  the companies or the government can raise long term funds. One way that the government or the companies can raise long term funds is through issuing bonds, where people buy bonds for  a set price and allows the government and the companies to use their money  for a certain period , but they are promised a higher return for allowing them to borrow money, the higher return is paid through interest which accrues on the money that the government or companies borrows.

Another way that the companies can raise long term funds in the capital market is through stock market. Companies sell the stocks, which are actually the ownership capital, to the general public as a way to raise money.

The lack of advanced and vibrant capital market can lead to underutilization of the financial resources. The developed capital market also provides access to the foreign capital for domestic industries.

The capital market consists of two markets: The first market is the primary market and the other is secondary market. Primary market is the market where the long term securities are issued for the first time and the secondary market is the market, where existing securities are traded.

Significance, role or functions of capital market

Capital market is also very important as is the money market. It plays a significant role in the national economy. The developed, dynamic and vibrant capital market can immensely contribute for speedy economic growth and development.

The important roles and functions of the capital market are as follows:

1)      Mobilization of savings: capital market is an important source for mobilizing idle savings from the economy. It mobilizes funds from people for further investments in the productive channels of an economy. In that sense it activates the ideal monetary resources and puts them in proper investments.

2)      Capital formation: It also helps in capital formation. Capital formation is the net addition to the existing stock of the capital in the economy. Through mobilization of ideal resources it generates savings; and the mobilized savings are then made available to the various segments of the economy such as agriculture, trade, industry, etc.  This helps in increasing capital formation.

3)      Provision of Investment Avenue:  Capital market raises funds for the longer period of time. Thus it provides an Investment Avenue for people who wish to invest their resources for a longer period of time. It also provides suitable rate of return also to the investors. Instruments such as bonds, equities, units of mutual funds and insurance policies, etc. definitely provide diverse Investment Avenue for the public.

4)      Speed up economic growth and development: Capital market enhances production and productivity in the national economy. As it makes funds available for long period of time, the financial requirements of the firms are met by the capital market. It helps in research and development.  This helps in increasing in production and productivity by generation of employment and development of infrastructure.

5)      Proper regulation of funds:  Capital market not only facilitates the fund mobilization, but it also helps in the proper allocation of these resources. It can have regulations over the resources that it can direct funds in a qualitative manner.

6)      Service provision: As an important financial set up, capital market provides various types of services. It includes long term and medium term loans to industries, underwriting services, consultancy services, etc. These services help the manufacturing sector in a large spectrum.

7)      Continuous availability of funds: Capital market is a place where the Investment Avenue is continuously available for the long term investment. This is a liquid market as it makes funds available on the continuous basis. Both buyers and sellers can easily buy and sell securities as they are continuously available in the market. Basically capital market transactions are related to stock exchanges. Thus the marketability in the capital market becomes easy.

What is money market?   

Money market means market where money or its equivalent can be traded. Money is synonym of liquidity. Money market consists of financial institutions and dealers in money or credit who wish to generate liquidity. It is better known as a place where large institutions and government manage their short term cash needs. For generation of liquidity, short term borrowing and lending is done by these financial institutions and dealers. Money Market is part of financial market where instruments with high liquidity and very short term maturities are traded. Due to highly liquid nature of securities and their short term maturities, money market is treated as a safe place. Hence, money market is a market where short term obligations such as treasury bills, commercial papers and bankers acceptances are bought and sold.

According to Crowther, "The money market is a name given to the various firms and institutions that deal in the various grades of near money."

According to the RBI, "The money market is the centre for dealing mainly of short character, in monetary assets; it meets the short term requirements of borrowers and provides liquidity or cash to the lenders. It is a place where short term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers, again comprising institutions and individuals and also by the government."

According to Nadler and Shipman, "A money market is a mechanical device through which short term funds are loaned and borrowed through which a large part of the financial transactions of a particular country or world are degraded. A money market is distinct from but supplementary to the commercial banking system."

These definitions help us to identify the basic characteristics of a money market. A money market comprises of a well organized banking system. Various financial instruments are used for transactions in a money market. There is perfect mobility of funds in a money market. The transactions in a money market are of short term nature.

Money market is an important part of the economy. It plays very significant functions. As mentioned above it is basically a market for short term monetary transactions. Thus it has to provide facility for adjusting liquidity to the banks, business corporations, non-banking financial institutions (NBFs) and other financial institutions along with investors.

The major functions of money market are given below:-

1. To maintain monetary equilibrium. It means to keep a balance between the demand for and supply of money for short term monetary transactions.
2. To promote economic growth. Money market can do this by making funds available to various units in the economy such as agriculture, small scale industries, etc.
3. To provide help to Trade and Industry. Money market provides adequate finance to trade and industry. Similarly it also provides facility of discounting bills of exchange for trade and industry.
4. To help in implementing Monetary Policy. It provides a mechanism for an effective implementation of the monetary policy.
5. To help in Capital Formation. Money market makes available investment avenues for short term period. It helps in generating savings and investments in the economy.
6. Money market provides non-inflationary sources of finance to government. It is possible by issuing treasury bills in order to raise short loans. However this dose not leads to increases in the prices.

Apart from those, money market is an arrangement which accommodates banks and financial institutions dealing in short term monetary activities such as the demand for and supply of money.

Difference Between Money Market and Capital Market

The money market and the capital market are interrelated. The main points of difference between these two markets are as follows:-

1. Maturity
 In general, these two markets are separated on the basis of the maturity of the credit instruments related to these markets. The maturity of the instruments of money market is one year or less than one year. On the other hand, the maturity of the instruments of capital market is more than one year.

2. Risks
 The risks are less in money market. Because, there is less possibility of default of the credit of less than one year maturity. Likewise, the risk of interest rate is also low in the money market. On the other hand, the credit of the capital market is of long term nature. Due to this risks are more and are of varied nature in capital market.

3. Instruments
 The main instruments of money market are -treasury bills, commercial papers, certificate of deposit which are of short-term nature. On the other hand, the main instruments of the capital market are -debentures, equities or shares and government securities which are of long-term nature.

4. Institutions
 The different financial institutions related to short-term credit participate in the money market. But there is predominance of commercial banks. In fact, the commercial bank is an institution related to the money market. On the other hand, different kinds of financial intermediaries participate in the capital market. The main participants of the capital market are -development bank, finance company, provident fund, insurance company, Investment Company and so on. The service institutions are also involved in the capital market such as investment banking, commission brokers association, investment consultancy etc. In recent clays, the commercial banks also provide long-term loans to some extent. So they may also be included among the participants of the capital market.

5. Finance
 The money market deals in only short-term funds. It receives short term deposits and also provides the short-term credit. On the other hand, the capital market receives long-term deposits and also grants long term loan and equity capital to the business and the government.

6. Relation with the Central Bank
 The money market has close and direct relationship with the central bank. The central bank implements its monetary policy through this market. The central bank directly regulates the commercial banks in the money market. On the other hand, the central bank has influence over the capital market only indirectly through money market. Similarly, the institutions of the capital market are less regulated by the central bank.