Definition
Money market refers to the segment of the financial market where short-term securities and investments with maturity of less than one year are traded. On the other hand, the capital market is where long-term securities such as stocks and bonds, with maturity extending beyond one year, are bought and sold. Both serve as mechanisms for borrowing, lending, and raising funds, but differ primarily in the duration of their investments and securities.
Key Takeaways
- Money Market and Capital Market are segments of the financial market where funds are borrowed and lent. The Money Market deals with short-term finance whereas the Capital Market deals with long-term finance.
- The Money Market supports short-term borrowing and lending, mostly securities that mature within a year such as Treasury bills and short-term bonds. On the other hand, the Capital Market is all about long-term securities such as stocks and bonds typically with maturity date that extends beyond one year.
- The Money Market is known for its high liquidity and lower returns, making it highly suitable for investors seeking low risk. Conversely, the Capital Market is characterized by higher returns, but it comes with increased risk due to longer maturity period.
Importance
The distinction between money market and capital market is crucial as it underscores two types of financial markets that serve different purposes within an economy.
The money market refers to a section of the financial market where financial instruments with high liquidity and short-term maturities are traded, providing a quick and safe place for businesses and individuals to temporarily store, or “park” funds.
On the other hand, the capital market is where long-term debts and equity-backed securities are bought and sold, making it key for raising long term capital for businesses and providing investment opportunities for institutions and individuals.
Understanding the differences between the two is important as it can aid individuals and corporations in making informed financial decisions according to their liquidity requirements, risk tolerance, and investment horizons.
Explanation
The money market and capital market serve vital roles in economy by providing avenues for funds mobilization between entities in need of funds and those with an excess of it. The purposes and uses of these two markets, however, are fundamentally distinct. Money markets primarily deal with short-term lending and borrowing, typically dealing with securities that mature in less than a year. Main investors in this market include commercial banks and large corporations looking for short-term liquid investments.
These markets often help businesses meet their short-term requirements and help curb issues regarding liquidity crunches. Examples of money market instruments include Treasury bills, certificate of deposits, and commercial papers. On the other hand, the capital market is a broader and deeper market dealing with long-term securities. These tend to be investments spanning for more than a year and even to perpetuity in some cases.
The capital market’s primary role is to make longer-period loans available to businesses and government institutions to finance long-term projects such as infrastructure, residential and commercial construction, or expansion activities. They are an essential source of funds for companies looking to grow and expand their operations. Instruments in the capital market include stocks, bonds, debentures and mortgage loans. This market is ideal for investors like mutual funds, hedge funds and individuals who are willing to undertake a higher risk for higher potential returns.
Examples of Money Market vs Capital Market
Treasury Bills vs Initial Public Offerings (IPOs)Treasury Bills, which are short-term debt investments issued by a government to finance their debt, typify a kind of security you’d find in the money market. They are relatively low-risk, with maturity periods typically less under a year.In contrast, Initial Public Offerings (IPOs) – where companies sell their stocks to the public for the first time to raise funds – are an example of a financial activity in the capital market. Compared to T-bills, IPOs represent an ownership stake in a company and are typically higher-risk, higher-reward investments meant for longer time periods.
Certificates of Deposit vs BondsCertificates of deposit (CDs) offered by banks as a type of time deposit with a specific maturity date are part of the money market. They are considered one of the safest investments, with low returns but guaranteed capital safety.On the other hand, bonds, which are long-term debt instruments issued by corporations or governments to fund various projects or activities, fall under the capital market. Investors can expect to receive periodic interest payments and the return of principal at maturity, but the risk depends on the creditworthiness of the issuer.
Commercial Paper vs Real Estate InvestmentCommercial paper, which is a form of short-term unsecured debt issued by banks or corporations, falls under money market instruments. They are usually issued at a discount and redeemed at face value, and are commonly used for short-term financing needs.Conversely, investing in real estate such as residential properties, office buildings, or shopping malls, is an example of investment in the capital market since it usually involves a larger amount of money and longer time horizon. This type of investment is relatively risky, with the possibility of high returns or losses based on the market’s performance.
FAQ: Money Market vs Capital Market
What is Money Market?
The money market is where short-term obligations such as Treasury bills, commercial paper and bankers’ acceptances are bought and sold. It’s a segment of financial market where financial instruments with high liquidity and short-term maturities are traded. The aim of the money market is to provide quick liquidity to investors looking to park their funds for a shorter duration.
What is Capital Market?
Capital market is a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. The trading involves both, newly issued securities and existing ones. The primary role of the capital market is to channelize investment from investors who have surplus funds to the ones who are running a deficit.
What is the main difference between Money Market and Capital Market?
The major difference between the two lies in the investment period, risk involved, returns, and types of instruments and institutions. Money markets involve short-term borrowing and lending, typically within a year, while capital markets involve long-term assets with maturity period of more than a year.
Which one is considered riskier, Money Market or Capital Market?
Capital markets are generally riskier than money markets. The time factor plays a major role here. Since investments in the capital markets are made for a longer time duration, they are more prone to risks such as interest rate fluctuations, economic downturns and so on. On the other hand, money market securities, due to their short-term nature, offer lower returns but carry less risk.
Related Entrepreneurship Terms
- Short-term vs Long-term investments: Money markets involve short-term investments, usually with a maturity date of less than one year. Capital markets, on the other hand, deal with long-term investments, such as bonds and stocks, which have a maturity period of more than one year.
- Liquidity: Money markets are considered more liquid because the securities can be bought or sold quickly. Capital markets may not offer this high level of liquidity, especially for certain securities like stocks and bonds.
- Risk Level: Money markets are generally considered to have a lower risk level compared to capital markets. This is because the investments in the money market have a shorter maturity period, which reduces uncertainty.
- Instruments: The common instruments traded in the money market include treasury bills, certificate of deposits, bankers acceptances, etc. In the capital market, instruments traded include shares, debentures, bonds, etc.
- Regulation: Capital markets are typically more regulated than money markets. This includes oversight by regulatory bodies like the Securities and Exchange Commission (SEC) in the U.S
Sources for More Information
- Investopedia: This website contains a wealth of information on various financial topics including the differences between the money market and the capital market.
- The Balance: This site provides expert advice on personal finance and money management, including detailed articles on the money market and the capital market.
- Corporate Finance Institute: This professional website offers in-depth educational resources about industries like finance and accounting, including articles on money market and capital market.
- Khan Academy: This non-profit educational organization provides free online courses in various disciplines, including finance and capital markets.
