In the world of financial markets, two major segments stand out: the money market and the capital market. Although both contribute to the transfer of money within the economy, they play different roles.
The Money market is concerned with borrowing and lending of money for a short period, usually less than a year. It is perfect for meeting daily liquidity needs. However, the capital market is involved with long-term investments such as stocks and bonds, helping companies to raise funds for expansion.
Understanding the difference between the money market and the capital market is beneficial to investors, finance students, and anyone interested in the functioning of the economy.
Here, in this blog, you will get to know what each of them is, how they work, their characteristics, examples, and which of them may be more suitable for your financial aims.
Table of Contents
What is the Money Market?
The money market is a market that deals in money and highly marketable securities that are liquid. It does not function like the stock exchange; trades are generally conducted by electronic means or over the counter. Honor of commitment and creditworthiness is one of the significant characteristics of the money market.
The money market forms a significant component of the financial system, as it offers a way to create a balance of excess amounts that financial institutions with funds have and the needs of the institutions that require financing over short durations of stay, including overnight and up to one year.
Money market offers a non-inflationary means of funding government deficits and enabling governments to execute monetary policy through open market operations, as well as give a market-based reference level against which to set interest rates.
What is the Capital Market?
A capital market is a securities market where the government and companies sell equity and debt instruments to raise funds.
The buyers in this market invest over a longer period. Capital markets carry higher risks due to market fluctuations and the long-term nature of investments. The majority of investors seek the capital markets in order to save for education or retirement.
The securities sold in the capital market are normally long-term type financial instruments such as: Treasury Bonds, Corporate Bonds, debentures, shares, or stocks of companies.
What is the Difference Between Money Market and Capital Market?
Comparing the money market and capital market, there are a few things that distinguish one from the other. You will understand money markets and capital markets better when you know the major differences between the two.
| Basis of Comparison | Money Market | Capital Market |
| Definition | The market deals with short-term funds and securities with maturities of less than 1 year. | The market deals with long-term funds and securities with maturities over 1 year. |
| Time Horizon | Short-term (up to 1 year). | Long-term (more than 1 year). |
| Instruments Traded | Treasury bills, commercial paper, certificates of deposit. | Stocks, bonds, debentures, and mutual funds. |
| Objective | Provides liquidity and working capital. | Supports long-term investment and capital formation. |
| Risk Level | Low risk due to short duration and high liquidity. | Higher risk due to market fluctuations and long duration. |
| Return on Investment (ROI) | Lower returns. | Higher potential returns. |
| Market Participants | Banks, central banks, corporations, NBFCs. | Investors, companies, the government, and financial institutions. |
| Regulatory Body in India | It is regulated by the Reserve Bank of India (RBI). | It is regulated by the Securities and Exchange Board of India (SEBI). |
| Liquidity | Highly liquid and easily tradable. | Comparatively less liquid. |
| Credit Risk | Lower credit risk. | Higher credit and default risk. |
| Investment Purpose | Meant for short-term borrowing and lending. | Meant for long-term wealth creation. |
| Examples of Instruments | Call money, treasury bills, and commercial papers. | Equity shares, preference shares, debentures, and bonds. |
| Maturity Period | Less than 1 year. | More than 1 year or perpetual. |
| Impact on Financial Planning | Best for managing short-term cash flows. | Essential for building long-term investment portfolios. |
Although there are several differences between capital and money markets, the above-mentioned differentiates them well. Now, let’s discuss both markets in detail.
Main Participants in the Money Market
The money market consists of various participants from central banks and government corporations to international brokers.
- Central Banks (e.g., RBI)
- Commercial Banks
- Non-Banking Financial Companies (NBFCs)
- Mutual Funds
- Large Corporations
- Insurance Companies
- Government and Public Sector Units (PSUs)
- Primary Dealers and Brokers
Main Participants in the Capital Market
The capital market consists of various participants from the stock exchange and brokers to market regulators and depository participants.
- Retail Investors
- Institutional Investors
- Listed Companies
- Stock Exchanges (e.g., BSE, NSE)
- Regulators (e.g., SEBI)
- Investment Banks
- Brokers and Sub-Brokers
- Depositories (e.g., NSDL, CDSL)
- Portfolio Managers
- Mutual Funds and Asset Management Companies (AMCs)
Key Features of Money Market
- The money market has no geographical limitation like a traditional stock exchange. These monetary assets could be distributed across a large geographical space since the financial institutions that deal with them could be far apart.
- Although there are many centers of money market in Mumbai, Calcutta, Chennai, etc., none of them are independent individuals, and each one is interlinked and interrelated with the others.
- It is associated with everything that trades in money or financial resources.
- It is not one homogenous market. The sub-markets are of various forms, i.e., Call money market, Bill market, etc.
- The money market brings a connection between the RBI and banks, and it explains the monetary policy and management of money.
- It is possible to conduct transactions without the assistance of brokers.
Key Features of the Capital Market
- Connects borrowers and investors: Capital markets have one specific task, and that is to bridge the gap between lenders and those who need money.
- Capital formation: Capital formation is a crucial part of the capital market. It is timely in providing finances to address the financial needs of different sectors of the economy.
- Control security prices: Capital markets encourage the stabilization and rational pricing of securities, ensuring fair and transparent trading in securities. The borrower is charged either the standard rate of interest or the minimum rate of interest. Security prices in the economy become stable as a result of this.
- Provides opportunities to investors: The capital markets also provide a diversity of financial instruments in line with the requirements of the investor. In spite of some risks, the investors can get a higher rate of return in the capital market.
- Saves time and cost of transaction: The whole process of trading is faster and cheaper in the capital market. The trading process is automated, and this increases the pace of the whole process.
- Capital liquidity: The investors can sell their assets to a third party on the capital market in exchange for cash.
Types of Money Market
In India, various forms of money market instruments provide constant returns to those who want to invest with low risk. Below are some of the common instruments of the money market:
1. Call Money Market
Call money market is the most critical part of the organised money market. It deals with call loans or call money on a day basis. The participants of the call money market are mainly banks; hence, it is also known as the interbank call money market.
Those banks that have a short-run deficiency of funds constitute the demand side, whereas those banks that have a temporary excess of funds constitute the supply side of the call money market.
2. Certificate of Deposit (CD)
The commercial bank issues these certificates at a discounted rate, and the duration of holding these certificates normally lasts between seven days to a year. CDs act similarly to a bank fixed deposit, but their negotiating factor and liquidity is higher.
Since the Reserve Bank of India (RBI) launched CDs in 1989, they have been the preferred investment for investors in need of short-term assets, since they are free of risk but yield a higher rate of interest compared to fixed deposits.
3. Treasury Bills
They are raised whenever the government of India needs funds to fulfil short-term demands. T-bills are issued at a discounted price and can be sold through primary and secondary markets.
The risk that accompanies treasury bills is minimal since the sovereign guarantees the asset. Nonetheless, these securities are not interest-bearing. This is because the profit will be only the difference between the maturity value of the bill and the purchase price, taking a discount.
4. Commercial Papers
It is an unsecured medium of money market issued by well-established corporations in the form of promissory notes. The maturity of these instruments is less than one year. Hence, the interest rate of these instruments is very low when compared with the interest rate charged by other debt security instruments.
This is an instrument of the money market that allows corporate borrowers to access short-term borrowing through the direct offering of capital to the market.
5. Repurchase Agreements
Also called buybacks, they are contracts between two parties to repurchase the security in the future by the issuer, who provides a promise to buy back later. The repurchase agreements typically involve trading in government securities, and so only two parties who are authorized by the RBI can engage in such transactions. The terms of purchase date and rate of interest are already determined.
6. Banker’s Acceptance
This is a financial document issued by commercial banks, which assures the lender of a future payment. The terms of repayment are well stated in the document, with the date of repayment and the amount of repayment. This safe and reliable instrument has a maturity period of between 30 days to 180 days.
Types of Capital Market
The capital market in India is classified into two parts: the primary market and the secondary market.
1. Primary capital market
In the primary capital market, companies, governments, and institutions in the public sector raise capital in the form of bonds that are issued. Major capital markets are the corporations that issue new stocks to the market as an initial public offering (IPO) to accumulate funds.
Thus, in a primary capital market, particular investors buy stocks directly from the issuing company. The characterisation of primary markets reflects the exchange of new issues of stocks and other securities.
One such instance would be when a business becomes publicly traded and issues stocks and bonds to both large-scale and institutional investors, such as hedge funds and mutual funds.
2. Secondary capital market
Financial and investment instruments like stocks, shares, and bonds, among others, in the secondary capital markets, are sold and bought by customers. Exchange and trade of securities is the main characteristic of a secondary capital market that is characterised largely by the kinds of securities that exist or parts of securities issued previously.
The Bombay Stock Exchange (BSE), National Stock Exchange (NSE), the New York Stock Exchange (NYSE), and NASDAQ are some examples of secondary capital markets.
The secondary market includes investment platforms that are regulated by a financial authority like the Securities and Exchange Commission (SEC), where already issued or existing securities are sold among investors. This implies that the issuing companies are not directly involved in the secondary market transactions.
How does the Money Market Work?
The money market is a financial system in which short-term lending and borrowing occur, which on terms is less than 1 year. It assists companies, banks, and governments in fulfilling their short-term liquidity requirements.
Here’s how it works step by step:
- Short-Term Instruments: These are instruments that are sold and purchased in the money market within a year and are short-term, highly liquid, low-risk securities. Some types are: Treasury Bills (T-Bills), Certificates of Deposit, Commercial Papers, and Call Money.
- Major participants: The major players include commercial banks, RBI, NBFCs, mutual funds, large corporations, government, etc.
- Borrowing and Lending: Those who have excess money at hand lend to those having short-term imbalances. As an illustration, banks borrow money from one another on an overnight basis to fulfill reserve demands.
- Low Risk, Low Return: The instruments mature within a short period, thus returns are also low but stable since the default risk is low.
- Regulation: The money market in India is regulated mainly by the RBI to provide liquidity, and inflation is also regulated.
Now that you are familiar with the key difference between money market and capital market, their role, features, and how they work. So, for a better understanding of concepts: money market vs capital market, let’s get into the examples of both markets.
How does the Capital Market Work?
The capital market acts as a marketplace where long-term finance can be raised by individuals and companies, and governments. It brings together investors with money to invest and organizations in need of money to expand, build infrastructure, or other forms of long-term plans.
Here’s how it works step by step:
- Issuing Securities: Companies sell stocks (equity) or bonds (debt) to raise capital. This occurs in the primary market, where new securities are offered in the market initially (e.g., using IPOs).
- Buying and Selling: Once they have been issued, these securities are exchanged through a secondary market (for example, stock exchanges such as NSE or BSE) wherein investors purchase and sell secondary securities.
- Price Determination: The prices of securities change depending on demand, supply, performance of the company whose securities are being traded, as well as the state of the economy.
- Returns to Investors: Investors receive returns as dividends (in stocks) or interest (in bonds) and also capital gains from selling appreciated securities.
- Regulation: Regulatory authorities such as SEBI govern the capital markets, ensuring there is transparency to protect the investor and to avoid fraud.
Examples of Money Market Instruments
Various short-term financial instruments exist in the money market that assist in handling liquidity and short-term funding needs. These are mostly low-risk, highly liquid securities with maturities of less than a year.
1. Treasury Bills (T-Bills)
T-Bills are short-term-securities issued by the government and have a maturity of either 91, 182, or 364 days. They are regarded as risk-free, and they are discounted.
2. Commercial paper (CP)
Promissory notes issued by large corporations are short-dated and unsecured notes issued to facilitate working capital. These are normally issued between 7 days and 1 year.
3. Certificates of Deposit (CD)
Money that is deposited by banks with individuals or institutions in the form of a time deposit. They are traded in the secondary market and bear a fixed interest rate.
4. Call money and Notice money
Extremely short-term funds borrowed among banks as Call Money on a 1-day basis or Notice Money up to 14 days.
5. Repurchase Agreements (Repo)
A form of short-term borrowing in which a security is sold on a repurchase basis, at a specified time and price.
Examples of Capital Market Securities
The capital market provides a variety of financial instruments that can last long, and can be applied by businesses in raising funds and investors in building a portfolio. These securities are mainly applied in investment with a maturity of over one year.
1. Common stock- Equity Shares
These are issued by companies to raise the stock capital. Investors act like associates and earn dividends, capital gains in case of an increase in share prices.
2. Preference Shares
They provide the investor with a pre-determined dividend and also a precedence over the common shareholders in the event of liquidation, although they typically do not allow them the right to vote.
3. Debentures
Open-ended debt certificates that companies utilize to obtain money with a fixed rate of interest. The debenture holders are not the owners but the creditors.
4. Corporate Bonds
Debt instruments are issued by companies to finance themselves long-term. Bondholders do not receive dividends, but rather a regular interest. As well, the bondholders are paid at maturity.
5. The Government Securities (G-Secs)
The government issues long-term bonds as a way of financing fiscal operations. They are risk-free and give consistent returns.
Which Market is Better for Investors: Money Market vs Capital Market
Your investment goals, risk tolerance, and mode of preference for the investment are some of the factors that will determine whether to invest in the money market or the capital market. Money markets can be recommended to people who want to invest in low-risk, high-liquidity investments with modest but steady returns.
On the contrary, the capital market would suit investors who can easily tolerate the risk taken against the possibility of earning more. The selection of the market to enter will take place based on the personal financial objectives, tolerance to risks, and the motivation of the individual for the markets.
To find out about which investment opportunities best suit your needs, either discuss these opportunities with your financial advisor or do the research yourself. Each has its own advantages and disadvantages; it all depends on your personal choice. To make your research process easier, we have already mentioned the major difference between the money market and the capital market.
Importance of These Markets in Economic Development
Capital markets are important in the economy because they involve raising funds by investors for businesses and the government. They allow businesses the required amount of capital to grow and experiment, and investors could get some returns on their investment as well.
The money market has a significant role in promoting economic growth and business capital development. Financial markets allow access to capital, effective allocation of capital, funding innovative ideas, and financial risk management, in the process creating an economic landscape that favors the growth of businesses and overall prosperity of the economy.
Consequently, the government and regulators should help to make sure that the financial market is stable and healthy, so that it can help enhance their role in driving sustainable economic growth.
Alternative Investments to Money and the Capital Market
Money and capital markets are essential components of the financial system, but alternative investments are available.
- Cryptocurrency Markets: A new way to invest is digital currencies such as Bitcoin, XRP, and Ethereum. Backed by blockchain technology, they offer privacy and possible gains. Nonetheless, they are highly unstable and not completely controlled.
- Real Estate: Real estate may generate a smooth flow of rent and, in the long term, may gain value, but it needs a lot of money and is connected to its risks.
- Private Equity: It invests in companies that are not publicly traded on stock exchanges. This can provide various opportunities, but it can be more risky and illiquid.
- Peer-to-Peer Lending: On the internet, individuals can lend money through a digital platform to others or small firms without referring to banks. It gives borrowers access to funds at a lower rate than they might qualify for with a traditional lender. But lenders ask for higher returns in exchange.
- Commodities: A portfolio can be diversified through investing in gold, oil, or crops. They can hedge against inflation, though the prices may effectively vary. There are commodity investments that could be procured by using the capital markets.
Conclusion
One should know the difference between money market and capital market when wishing to learn about finance. Money markets are excellent to place short-term and safe investments, whereas the capital markets exist to achieve long-term development with more risks and returns. They both have enormous roles in maintaining a healthy economy. Having a clear understanding of these differences can help you to make informed decisions regarding the investment in the money market or the capital market.
FAQs
1. What are the similarities between a money market and a capital market?
Both the money market as well as the capital market are aimed at facilitating the process of accessibility of capital by businesses, as well as by companies. Liquidity, duration, and currency of financial instruments traded are the fundamental differences between money and capital markets. The two also indicate how consumers may increase their money through investing.
2. What is the difference between the money market and the stock market?
Investment maturity in the money market generally takes one day to one year. There is no fixed maturity period in investment in the share markets because it is supposed to give growth over the long term. The investments made in the money market may be termed as low risk since they are short-term in nature, and the level of money raised is not utilized to finance risky projects.
3. What is the difference between money capital and real capital?
As much as money capital is a source of financial funds that can be invested, Real capital can be regarded as a source of physical resources applied in the process of production. Both are essential needs of economic growth and development, where money capital helps in investing and real capital helps in producing goods and services.
4. How can I invest in money market instruments and capital market securities?
The individuals may use several ways to invest in the money market instruments and capital market securities, including opening a demat and a trading account, investing in a money market fund, or purchasing government securities directly.
5. What is the difference between capital markets and money markets?
The key difference between capital markets and money markets is that capital markets carry higher risks due to market fluctuations and long-term nature of investments, whereas the money market is a market it deals in money and highly marketable securities, which are liquid.