As the name implies, financial markets are a type of marketplace where you may sell and purchase assets such as bonds, shares, foreign exchange, and derivatives. They go by many names, including "Wall Street" and "capital market," yet they all mean the same thing. Simply explained, financial markets allow businesses and investors to raise funds to grow their operations or create more revenue. Maintaining and developing money are the two options for wealth management. It's difficult to know which course to take. Recent reports of rising inflation have made investors nervous.
There are two types of financial markets in which you can invest your money: the money market and the capital market. The money market and the capital market are two major segments of the global financial market, where the funds are invested for short- and long-term borrowing and lending.
What is Money Market?
A money market is a market for securities with a maturity of less than one year. The money market's securities are short-term and extremely liquid. Money market products include treasury bills, repurchase agreements, certificates of deposit, and banker's acceptances.
The basic purpose of the money market is to meet the economy's immediate financial demands. This is frequently accomplished by altering the cash positions of various market participants. In other words, the money market meets the economy's liquidity requirements.
The money market also aids in the mobilisation of cash across various market sectors. Money market investments are made when investors have excess funds in the near term. Other market participants use this money to meet their short-term monetary requirements. Money market products have significant liquidity, making it easier to move savings into investments.
Interest rates on money market instruments serve as a benchmark for all other debt securities. Furthermore, the RBI and the government use money market interest rates to set monetary policy in the future.
RBI, banks, non-banking financial companies (NBFCs), and acceptance houses are the primary actors in the money market. Call and notice money can also be accessed by All India Financial Institutions and Mutual Fund firms. Treasury notes and other money market instruments can be purchased by individuals, businesses, and other entities.
Features of Money Market
The money market has the following characteristics:
1. Liquidity: Money market instruments are highly liquid assets that provide investors with a steady stream of income. The instruments' short maturity makes them a highly liquid asset. As a result, they're a close match for carrying cash.
2. Security: Money market instrument issuers have a good credit rating, and the returns are guaranteed. Furthermore, there is essentially no chance of losing the money. As a result, these instruments are among the safest and most secure solutions on the market.
3. Returns: Money market instruments are sold at a discount to their face value and have a predetermined maturity date. These investments, unlike the capital market, have fixed returns that are heavily tied to market performance. As a result, the investor can readily predict how much money they will make from the investment. As a consequence, individuals can pick the optimal alternative for their financial goals and time horizon.
Types of Money Market Instruments
The various forms of money market instruments are as follows:
1. Treasury Bills (T-Bills): To raise finances, the Reserve Bank of India issues Treasury Bills (T-Bills) on behalf of the government. T-bills are short-term financial instruments with a one-year maximum maturity. T-bills are available for 14 days, 91 days, and 364 days. They are sold at a discount and are reimbursed at face value when they mature.
2. Commercial Bills or Bills of Exchange: Businesses use bills of exchange to meet their short-term cash needs. A broker or a bank can discount the creditor's bill of exchange. Because they may be passed from one person to another, they are very liquid instruments.
3. Commercial Papers (CP): Commercial Papers (CPs) are issued by large enterprises and corporations to raise finance for short-term commercial needs. These businesses have excellent credit ratings, which act as collateral for unsecured commercial papers. The maturity of CPs is predetermined and ranges from 7 to 270 days. Investors can also trade CPs on the secondary market.
4. Certificates of Deposits (CD): CDs are negotiable term deposits issued by corporations, scheduled commercial banks, trusts, and individuals. They are accepted by commercial banks and function similarly to a promissory note. A CD might last anywhere from three months to a year. CDs issued by financial institutions, on the other hand, have a longer term, ranging from one to three years.
5. Repurchase Agreements: A repurchase agreement, also known as a repossession agreement, is a legal contract between two parties. A security is sold to a third party with the promise of repurchasing it from the buyer at a later date. The seller returns the security at a predetermined date and price. The repo rate is the interest rate charged by the buyer. Repos are a quick solution to meet short-term capital needs while simultaneously providing a good return to the buyer.
6. Banker's Acceptance: A banker's acceptance is a financial instrument created in the name of a bank by an individual or a corporation. On a given date, the issuer must pay the instrument bearer a specific amount. It normally takes between 30 and 180 days after the issue has occurred. It is a safe financial instrument because a commercial bank guarantees the payment.
What is Capital Market?
The capital market is a market for long-term investments. In other words, when industry participants require financing over a long period of time, they turn to the capital market. More than one year is the maturity of the capital market instruments. Capital market participants deal in securities such as stocks, bonds, ETFs, debentures, and derivatives such as futures, options, and swaps.
Savings are converted into investments in the capital market. They also aid corporations in funding long-term projects. These marketplaces make use of competitive pricing mechanisms to aid inefficient capital allocation. They also make it possible to value financial securities listed on the stock exchange more quickly. India's capital markets are well-regulated and organised. Capital markets, while riskier than money markets, have the potential to provide good long-term returns.
Stock exchanges such as the BSE, NSE, and MCX (Commodity Exchange), as well as banks, brokers, insurance firms, and other financial organisations, serve as capital market intermediaries. Capital markets mobilise funds into investments through these intermediaries.
Features of Capital Markets
Capital markets have the following characteristics:
1. Security: The capital markets are regulated by the government. They are governed by a set of rules. As a result, investors consider it a secure trading environment.
2. Channelizes savings: Capital markets serve as a conduit for savings and investments. They encourage economic growth by channelling savings from savers to industrial actors.
3. Long-term investment: Capital markets provide as a foundation for long-term investments. Capital markets are available to every investor interested in long-term investments.
4. Wealth Creation: The capital market allows investors with excess funds to invest in capital market products such as stocks and bonds, allowing them to build wealth through compounding.
5. Assists intermediaries: The capital market facilitates the transfer of savings from savers to borrowers through intermediaries such as stock exchanges, brokers, and banks. The capital market assists intermediaries in conducting business and earning income in this way.
Types of Capital Markets
The main market and the secondary market are two different types of capital markets.
1. Primary market: This is the new issue market, when corporations issue their first stock through an initial public offering (IPO). The company's shares are listed on the stock exchange when the IPO is successful. Private placements, rights offerings, and prospectuses are all used to raise money in the primary market. The funds will be utilised to assist the business expand and grow.
2. Secondary market: This is a market where listed shares and securities can be traded. A stock exchange is a place where people can purchase and sell securities. The major stock markets in India are the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), which account for the majority of equities trading and investment. Secondary markets such as the NSE and BSE are excellent examples.
Capital Market Instruments
1. Bonds: Bonds are debt securities that are traded on a stock exchange. Companies and businesses issue bonds to raise funds for their expansion and growth. Bondholders earn interest because bonds are debt instruments. The corporation repays the principal amount plus interest at the conclusion of the maturity period.
2. Stocks: Stocks reflect a company's ownership. Each share is a piece of the company's ownership. On the stock exchange, shares are traded, and their value is determined by market demand and supply. A shareholder is someone who owns stock in a corporation. Dividends go to shareholders. In the case of equity shares, they also have voting rights and can vote on significant corporate decisions at the annual general meeting. They receive a part of the assets when the liabilities are paid off after liquidation.
Differences between Capital Market and Money Market
Following are the key differences between money market vs capital market:
1. Funds: Money market funds assist a company in meeting its working capital requirements. As a result, each corporation borrows only a small portion of its total assets. On the other side, the firm's asset base is made up of funds raised through capital markets.
2. Function: The primary goal of money markets is to provide short-term liquidity to the economy. Capital markets, on the other hand, are crucial in directing the economy's savings toward growth and development.
3. Market nature: Money markets are unregulated, whereas capital markets are regulated and formal.
4. Instruments: Bills of Exchange or Commercial Bills, Treasury Bills (T-Bills), Commercial Papers (CP), Certificates of Deposits (CD), Repurchase Agreements, Banker's Acceptance, and Call & Notice Money are examples of money market instruments. Bonds and stocks are examples of capital market instruments.
5. Transaction mode: The majority of money market instruments are offered over the counter by brokers who assist parties in finding counterparties. The majority of capital market transactions, on the other hand, take place through exchanges. Exchange transactions are facilitated by dealers.
6. Liquidity: In comparison to capital market assets, money market products are more liquid. Despite the presence of market makers in capital markets, most money market products are highly liquid and yield excellent returns. Because money markets have a shorter maturity, many investors are prepared to put their money in them.
7. Period of Maturity: Money market products have a maturity duration ranging from one day to one year. While the maturity of the capital market instrument is long, there is no set time span.
8. Risk: Money market instruments are short-term investment possibilities, and the funds raised are not invested in high-risk enterprises. Money market instruments have become attractive low-risk investing options as a result. Capital markets, on the other hand, put the money raised into long-term projects. As a result, these devices are seen as more dangerous.
9. Returns: Money market returns equal the cost of capital or the current interest rate in the economy. Investors rarely make a profit that exceeds the rate of interest. On the other side, the potential earnings in the stock market are practically limitless. This could be related to the investors' willingness to take on risk over a longer period of time.
10. Participants: The money market's most active players are banks and other financial organisations. Short-term funding is generally sought by banks in order to demonstrate that they have the necessary reserves to issue the loans. Mutual funds and pension funds, for example, are required to keep a specific amount of liquid cash on hand as well. This is because investors who want to redeem their investments must be paid back. Cash, on the other hand, has no profit potential. Investing in money markets is the next best alternative. They're so liquid and risk-free that they can be used in place of cash. Most investors are aware that they can convert money market funds to cash without losing any of their investment value.
Stockbrokers, mutual funds, retail investors, underwriters, insurance firms, commercial banks, and stock exchanges are all participants in the capital market.
1. They are both involved in the financial markets. The financial markets' primary goal is to route funds and earn returns. The loan borrowing mechanism, in which lenders provide extra cash to borrowers, helps to keep the money supply stable.
2. Both are necessary for the economy's improvement since they meet the long- and short-term capital needs of businesses and industries. Individuals are encouraged to invest money in order to make a profit.
3. Investors can access each market according on their needs. Money markets are more liquid, but they pay lower returns, whereas capital markets are less liquid, but they provide higher returns at a higher risk. Money markets are regarded as safe investments as well.
4. However, market abnormalities and inefficiencies caused by some of the foregoing anomalies may not be sustained. Investors seek arbitrage opportunities to increase their returns as a result of such abnormalities. Money markets are thought to be safe, yet they can occasionally produce negative returns. Before investing in the short or long term, investors should consider the advantages and disadvantages of each financial instrument as well as the state of the financial market.