Differences between money market and capital market: Generally we think that both capital and money markets are same. But both the terms are different. In this article, let’s know here the difference between money market and capital market based on nature, functions, liquidity, funds security, profitability, role, and types of investors. We have also discussed below about the difference between money market and capital market based on their purposes, investment period, capital or types of funds, and return on investment (ROI). We have discussed about 12 parameters on which money market and capital market are differentiated below.
Table of Contents
What is Difference Between Money Market and Capital Market
There are 12 important bases of differences between money market and capital market. One of the significant and primary differences between money market and capital market is the period for which trade of financial assets or instruments is invested or borrowed i.e. sold and bought. The money market is the financial market where assets are invested for a short period i.e. less than one year. While the capital market is a financial market where traders sell and buy assets for a long duration i.e. more than one year. The major differences between money market and capital market are:
Top 12 Major Differences Between Money Market and Capital Market
Base of Difference | Money Market | Capital Market |
Meaning/Definition | Money market is a type of financial market where financial assets or instruments are traded between institutions and traders for a short period, up to one year. | Capital market is financial market where financial instruments or shares/securities are traded for long duration, more than one year |
Market Nature | Money markets are informal | Capital markets are formal |
Purpose | Fulfill short term investment and borrowing needs of business | Fulfill long term investment and borrowing needs of business |
Duration/Period | For short time, up to one year | For long time, more than one year |
Market Liquidity | Money market is highly liquid | Capital market is less liquid |
Functions | Money market increases funds’ liquidity in the economy | Capital market stabilizes the economy by long term investment |
Investment Amount | Assets of money market are expensive, so investment amount is huge | Equity shares’ or Securities’ value in capital market is low (appx. ₹10 to ₹100), so investment amount can be low |
Instrument/Asset | Treasury Bills (T-Bills), Certificate of Deposits (CDs), Commercial Papers (CPs), Repurchase Agreements (Repos), Govt. Securities, etc | Stocks or Shares, Bonds, Debentures, etc. |
Investor Types | Central bank, commercial bank, financial bank, financial companies, chit funds, etc. | Individual investors, underwriters, commercial banks, mutual funds, insurance companies, stock exchanges |
Capital Types | Money is borrowed by companies for working capital | Money is borrowed by companies for fixed capital |
Return (ROI) | Return on investment (ROI) is usually low in money market | Return on investment (ROI) is comparatively high in capital market |
Risk/ Safety/ Security | Money markets have low risk | Capital markets are comparatively more risky |
You knew 12 differences between money market and capital market in brief, let’s discuss about money market and capital market on individual bases separately below.
Money Market Vs Capital Market: On Definition, Features
The money market Vs capital market are differentiated on the basis of their definition and features. Let’s see the difference between money market and capital market as given below:
Definition of Money Market
Definition of Money Market: Money market is a type of financial market where financial assets or instruments are traded for short duration up to one year maturity period with high liquidity. It is a section of the financial market where investors and buyers sell and buy securities for short period maturities, for example – Treasury Bills, commercial papers, Repurchase Agreements, Certificate of Deposits (CDs), Banker’s Acceptance, etc.
Definition of Capital Market
Definition of Capital Market: Capital market is a type of formal financial market where buyers and sellers of financial instruments like Stocks or Shares, Debentures, etc. trade for longer periods, more than one year maturity, with low liquidity.
You will know the features of money market and capital market below.
Features of Money Market
The features of money market are the following:
- Money market is an informal unregulated financial market.
- Investments are for a short duration up to one year.
- It is a more liquid financial market where funds can be converted into cash easily.
- All trades of financial assets can be done through phone, email, text, etc.
- In the money market brokers are not needed for the trade or transactions of assets.
- The investors of the money market are the commercial bank, Central bank, Non-banking financial companies, financial companies, chit funds companies, etc.
- It is a low risk financial market and investments are safe comparatively.
- The return on investment (ROI) in the money market is low.
Features of Capital Market
The capital market has the following features:
- Capital market is a formal and regulated financial market.
- It is controlled or regulated by government rules and regulations.
- In it brokers or agents also present as a middle men between investors and borrowers.
- Here investments are for a longer period i.e. more than one year.
- It is a less liquid financial market.
- Here both commercial and non-commercial securities, financial instruments are traded.
- The financial instruments of the financial market are Bonds, Stocks or Shares, Debentures, etc.
- The investors of the capital market are Individual investors, underwriters, commercial banks, mutual funds, insurance companies, stock exchanges, etc.
- It is a high risk financial market and investments are risky comparatively.
- The return on investment (ROI) in the capital market is high.
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Difference Between Money Market and Capital Market Pdf: On Instruments’ Types
The difference between money market and capital market on the basis of financial instruments or assets which are sold and borrowed are different in nature and amount. The different instruments of money market and capital market are as follows:
Instruments of Money Market
The money market allows traders of financial assets or instruments to sell and buy for a short period. The central bank, Reserve Bank of India (RBI) in India, controls and monitors the interest rate of financial assets or instruments traded in money markets. There are a variety of financial instruments of money market like:
- Treasury Bills (T-Bills)
The Reserve Bank of India issues Treasury bills (T-Bills) on behalf of the Central Government for raising money. These T-Bills have short periods of maturities upto one year, currently with 3 different maturity duration i.e. 91 days, 182 days, and one year T-Bills.
These Treasury Bills are the safest short term investment which are backed by the Government of India. These are issued at a discount to the face value of T-Bills. The investors get the face value amount of the T-Bills at the maturity. Thus, the difference between the face value and the discount or initial value becomes the earning of the investors.
- Commercial Papers
Commercial Papers (CPs) are the financial instruments or promissory notes of money market issued by large companies and business houses raising capital to meet short term business needs. The security and guarantee of commercial papers depends on the firm’s or company’s credit rating and credibility. So CPs are issued by corporates, primary dealers (PDs) and All-India Financial Institutions (FIs).
The maturity period of commercial papers (CPs) starts from 7 days to 270 days. However, CPs can be traded by investors in the secondary markets. Commercial papers offer higher returns in comparison to treasury bills.
- Repurchase Agreements or Repos
Repurchase Agreements are money market’s financial instruments which are also called repos or buybacks. These are a formal agreement between sellers and buyers, where one party sells a security to another, with the promise of buying the same back at a later date from the buyer. These transactions are also known as Sell-Buy transactions.
The Repurchase Agreements or Repos are made between a bank and the Reserve Bank of India (RBI) or between two banks. Repos facilitate liquidity for financing loans for a short period.
- Certificate of Deposits (CDs)
Certificates of Deposits (CDs) are financial instruments or assets of the money market that are issued by banks and financial institutions. The issuing banks or institutions offer fixed interest rates to the buyers on the invested amount. The actual difference between a Certificate of Deposits (CDs) and a Fixed Deposits (FDs) is based on the value of principal amount to be invested. The CD’s principal amount is issued for large sums of money with one lakh or in multiples of one lakh thereafter.
The maturity period of CDs ranges from 7 days to 1 year, if issued by banks. CD’s maturity period ranges from 1 year to 3 years when the same is issued by financial institutions. This is the reason for restriction on the minimum invested amount CDs are more popular amongst banks and financial institutions.
- Banker’s Acceptance (BA)
Banker’s Acceptance is a financial instrument of the money market produced by an individual or a corporation in the name of the bank. It is issued for a short period ranging from 30 days to 180 days. For this the issuer of banker’s acceptance needs to pay the instrument holder a fixed amount on a predetermined date, which can be from 30 to 180 days. Banker’s Acceptance is a secure financial instrument as the payment is guaranteed by a commercial bank.
Banker’s Acceptance is issued at a discounted price of its face value, and the actual price (face value) is paid to the BA holder at maturity. Thus, the profit of the investor is the difference between the face value (actual price) of Banker’s Acceptance and its discounted price at which it is sold to the investor.
Banker’s Acceptance Working: The Banker’s Acceptance issuer submits a request to the bank and the bank verifies the issuer’s credit information. Then the bank takes a deposit from the BA issuer and issues a BA for a small fee. Thereafter, the Banker’s Acceptance (BA) holder can either receive its actual price i.e. face value at the time of maturity or sell it at a discount to some other buyer.
We have discussed one of the instruments of money market and capital market here, let’s discuss the assets of capital market next.
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Instruments of Capital Market
The capital market’s instruments are generally classified into two types:
A. Equity Shares or Security Stocks
- Equity Shares
The equity shares are the primary source of funds raising for a public limited or joint-stock company in the capital market. When an individual or institutions purchase the equity shares of a company they become shareholders of that company. The shareholders have the right to vote and also benefit from dividends when the company makes profits due to share’s price rises in the stock market. The shareholders are also regarded as the owners of a company since the time of shareholding.
- Preference Shares
The preference shares are the secondary sources of fund raising or finance for a public limited company in the capital market. The preference shareholders of the company enjoy exclusive rights or preferential treatment by the company in a special category. They are preferred to receive their dividend of profits before equity shareholders. But they are not given any voting rights of the company in decision making.
- Sweat Equity Shares
As per section 2 (88) of the Companies Act – 2013 the sweat shares are offered to the followings:
- The employees or directors of the company for their remarkable efforts and contribution in the development of the company or completion of a project.
- The technical expertise in the field of the employees or directors that accelerate a company’s functioning.
When they add value to the company through their extraordinary contribution in gaining the company’s intellectual property rights.
B. Debt Instruments or Security
Debt securities is a fixed income financial instrument, issued by central government or state governments, municipalities, and large companies to raise funds for infrastructural development, day-to-day operation, business expansion, acquisitions, paying off other debts, and other types of projects. It is a loaning instrument of the capital market where the issuer of bonds borrows the funds or money and investors buy the instruments. It gives lower returns in comparison to other capital instruments such as equity share, gold, and real estate over a long period. The debt instruments are classified into two categories, bonds and debentures.
- Bonds
Bonds are fixed income debt instruments of the capital market which are issued by the central or state government, and even by big companies for generating funds for specific purposes. Bondholders who provide funds are entitled to get periodic interest payment.
Furthermore, bonds carry a fixed lock-in period. And issuers of bonds are mandated to repay the principal amount on the maturity date to bondholders. Bonds are either secured by a physical asset or a guarantee. Bonda are of different types for example, inflation-indexed bonds, floating bonds, sovereign bonds, etc.
- Debentures
Debentures are debt instruments of the capital market issued by a company to raise funds or loans from the market for a specific purpose. These are unsecured investment options unlike bonds. Because debentures are not backed by any physical asset or collateral or guarantee. The investment or lending in debentures is entirely based on mutual trust of the buyer and seller. And in this case, investors become potential creditors of an issuing institution or company.
When the issuer redeems NCDs on maturity he/she has to pay the principal amount along with accumulated interest to the investor. The NCD is also called “redeemable debenture” as it carries a specific repayment date. Because of this clause, companies attract more investors for redeemable debenture.
Debentures are of two types, convertible debentures and non-convertible debentures.
(i) Convertible Debentures (CDs): These are debt instruments traded in the capital market which can be changed into equities after some time at the owner’s discretion.
(ii) Non-convertible Debentures (NCDs): These are opposite of convertible debentures which function like company fixed deposits and offer fixed return. However, it is not secured in nature. The NCDs are further divided into Call NCDs and Put NCDs.
A ‘callable NCD’ is the debenture where the issuer reserves the right to repay (redeem) the loan amount at any date before the maturity. On the other hand, Put NCDs allow the buyers or investors to have the right to redeem or sell the debenture before maturity in the market if its interest rate goes up to earn more profit.
The NCDs give an average return between 10 to 12 percent annually which is more than the other similar investment instruments in the market. Thus, NCDs offer better income or return than debt bonds, and bank fixed deposits. But NCDs are risky and not secured as bank FDs and debt bonds.
Non-convertible Debentures (NCDs) are liquid unlike the bonds and investors or buyers can buy or sell NCDs in the secondary market like a company’s equity shares. Thus, on liquidity criteria NCDs are considered between bonds and equities.
You have learnt about the different instrument of money market and capital market, let’s know the difference between money market and capital market on the parameters – nature, purpose, and duration below.
Difference Between Capital Markets and Money Market: On Nature, Purpose, Duration
The difference between capital market and money market on the basis of their nature, purpose, and duration of funding or investment in different assets or instruments are:
Money markets are an informal and organized exchange financial market where investors can lend and buyers can borrow funds for a short maturity period, generally one year or less. Whereas the capital markets are formal institutional arrangements to borrow and lend money for a longer duration say more than one year.
The purpose of the money market is to arrange funds for borrowers for day to day functionings and operation of their projects. On the other hand, the purpose of the capital market is to play an important role in the growth of a country’s economy by arranging and mobilizing funds for new projects, expansion, etc. for a longer period i.e. more than one year.
The important difference between money market and capital market in reference of liquidity, amount of investment, investors types, and ROI is given below.
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Money Market and Capital Market Difference: On Liquidity, Amount, Investors, & ROI
The money market and capital market differences are given here on the basis of liquidity of assets, amount of investments, investors’ types and return on investment (ROI). The money market is more liquid in comparison to the capital market. Because of high liquidity and short maturity period in the money market, there is low risk of financial instruments or investment there. On the contrary, there is high risk in the capital market due to low liquidity and longer period of financial instruments’ maturity.
The investment amount in the money market is huge because its assets are expensive. On the other hand, investment amount in the capital market can be low due to its security or equity shares’ value start approximately from ₹10 to ₹100. The return on investment (ROI) is usually low in the money market because of high liquidity and short term investment with low risk. But return on investment in the capital market is more for contrary reasons.
The investors in the capital market are individuals, underwriters, commercial banks, mutual funds, insurance companies, stock exchanges, etc. Whereas investors in the money market are Central bank, commercial bank, financial bank, financial companies, chit funds, etc.
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FAQs on Difference Between Money Market and Capital Market
Q. What is the difference of money market and capital market?
Ans. The money market and capital market function differently. The former facilitates the trade between investors and borrowers for one year or less with high liquidity. Whereas the capital market provides a platform for investment and borrowing of funds in equities shares and debt instruments like bonds and debentures for a longer period i.e. more than one year with low liquidity, high profitability, and high risk.
Q. What is the difference between capital and money?
Ans. The money market and capital market can be distinguished based on capital and money. Capital is the physical and non-physical assets like factories, education and skills which are used to make goods and services. While, money is primarily a means to exchange one good for another.
Q. What is money market and capital market with example?
Ans. The examples of money market and capital market: money market’s examples are certificates of deposit (CD), treasury bills, commercial paper, etc. whereas examples of capital market are equities shares, bonds, debentures, etc.
Q. What is the similarities between capital market and money market?
Ans. Both the money market and capital market are significant components of the international financial market. Both markets facilitate investors and borrowers sell and buy financial assets or instruments. Business firms and governments depend on both the markets for raising funds or money for different purposes.
Q. What are functions of capital market?
Ans. Functions of the money market and capital market are given in the table in the beginning. As functions of capital market are to provide a platform for moving capital or different capital instruments or assets to be used for more profits and boost the national economy or income growth.
Money Market and Capital Market Differences in Money Market and Capital Market
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