Financial Markets - Money Market vs Capital Market

Financial Markets: The financial market is a complex system comprising banks, development financial institutions (such as NABARD, SIDBI, IDBI), and non-banking financial institutions. This system, inclusive of regulatory bodies and organizations, facilitates the movement of debt and equity capital. Financial instruments within this market include shares, bonds, debentures, and more.

Financial Market Functions

1. Connecting Investors and Borrowers: It serves as a platform for investors and borrowers to interact.
2. Pricing Information: Through asset trades, it generates pricing information from buyer-seller interactions.
3. Ensuring Security: It ensures secure dealings with financial assets.
4. Ensuring Liquidity: This provides a way for investors to sell assets, ensuring liquidity.
5. Cost-Efficient Transactions: The market promotes cost-effective transactions and access to information.

• Money Market: Deals with short-term funds.
• Capital Market: Focuses on long and medium-term funds involving lending and borrowing.

What is a Money Market?

Money Market Functions

• Balancing Money Flow: The money market ensures a balance between the demand and supply of money for short-term transactions, maintaining monetary equilibrium.
• Boosting Economic Growth: By channelling funds to sectors like agriculture and small-scale industries, the money market plays a role in promoting economic growth.
• Supporting Trade and Industry: It provides necessary finance to trade and industry, including the option to discount bills of exchange, facilitating their financial needs.
• Implementing Monetary Policy: The money market acts as a mechanism for the effective implementation of monetary policies, contributing to the stability of the financial system.
• Facilitating Capital Formation: Offering short-term investment avenues, the money market encourages savings and investments, contributing to overall capital formation in the economy.
• Enhancing Liquidity: The money market ensures quick access to cash, enhancing liquidity for participants, which is crucial for smooth financial operations.
• Risk Diversification: It allows for diversification of risk by providing a range of short-term investment options, reducing the impact of financial uncertainties.
• Government Financing: The money market plays a role in government financing by providing a platform for short-term borrowing and lending activities supporting fiscal operations.
• Efficient Monetary Transmission: It facilitates the efficient transmission of monetary policies, ensuring that changes in interest rates and other monetary tools have a swift impact on the broader economy.

Money Market Features

1. Non-Inflationary Government Finance: The money market offers non-inflationary financial sources to the government through the issuance of treasury bills, enabling short-term loans without triggering price increases.
2. Diverse Participants: Comprising various organizations and institutions, the money market involves entities dealing in short-term debt instruments. Key players include the RBI, commercial banks, cooperative banks, non-banking financial companies like LIC, GIC, UTI, and specialized institutions like the Discount and Finance House of India (DFHI).
3. Key Money Market Instruments:

• Treasury Bills: Short-term government securities facilitating quick borrowing.
• Commercial Paper: Unsecured promissory notes issued by corporations.
• Certificate of Deposit: Time deposits offered by banks.
• Repurchase Agreements (Repos): Short-term borrowing and lending using securities as collateral.
• Call Money: Short-term funds lent and borrowed among banks.

What is a Capital Market?

Types of Capital Market

Primary Market:

• In this market, securities are issued for the first time. Examples include Initial Public Offers (IPOs) and follow-on public offers.
• Firms directly issue shares to the public, raising funds for long-term investments.
• The price is fixed by the firms, and there is no specific geographical location for these transactions.
• The regulatory authority overseeing this market is the Security & Exchange Board of India (SEBI).

Secondary Market:

• Existing securities are bought and sold here, as one investor sells to another investor.
• Prices in the secondary market are determined by demand and supply dynamics.
• Companies benefit from the secondary market by providing liquidity to existing shareholders.
• Similar to the primary market, there is no specific geographical location, and SEBI regulates this market as well.

Also Read: What Is a Stock Market?

Difference between Money Market and Capital Market

Financial Markets – Key Terms

1. Treasury Bills in Financial Markets: Treasury Bills are pivotal short-term instruments in Financial Markets. Issued by the RBI on behalf of the government, they carry maturities ranging from 14 to 364 days. These bills, though not interest-bearing, are freely transferable, creating liquidity in the market.
2. Commercial Bills in Financial Markets: Commercial Bills, also termed Trade Bills or Bills of Exchange, play a crucial role. They represent written acknowledgements of debt between business firms, facilitating credit transactions. These freely marketable instruments typically have a short-term horizon, lasting around 90 days.
3. Commercial Paper (CP) in Financial Markets: Commercial Paper , introduced in 1990, is a noteworthy aspect of Financial Markets. This unsecured promissory note, issued by corporations with a substantial net worth, provides short-term funding. It is traded at a discount on face value, offering flexibility in financing options.
4. Certificate of Deposit (CD) in Financial Markets: The Certificate of Deposit, introduced in 1989, is a significant financial instrument in the market. Issued by banks against deposits, it resembles Fixed Deposits but stands out as a negotiable and tradable asset. CDs cater to a timeframe ranging from 15 days to 3 years.
5. Discount and Finance House of India Ltd. (DFHI) in Financial Markets: DFHI, established in 1988 on the recommendation of the Vaghul Committee, plays a crucial role in enhancing liquidity in Financial Markets. As a subsidiary of RBI, it stimulates the money market by buying bills and short-term securities from banks and financial institutions, fostering the development of a secondary market.