Money and capital may sound like similar things but they are quite different when it comes to the markets. The primary difference between the money market and the capital market is in the short-term and long-term nature of investments. Let's consider an example.
Do you prefer a two-hour-long movie or shorter episodes of a series? The difference between the money market and the capital market is like the difference between a feature film and a web series. The money market is like the world of shorts, reels and short films, where the tenure of investments is shorter and primarily in debt or borrowing.
The capital market is like the world of feature films where a make a longer term of commitment and the investments may be in the form of equity and debt. With this broad understanding, let's take a deeper look at both these markets.
The money market, as it is aptly named, is a market for short term money. It deals in financial assets called money market instruments that comprise bonds and similar instruments of borrowing short-term money with a maturity period ranging from overnight to one year. Their primary objective is to provide short-term liquidity to carry out day-to-day tactical operations of a business. Here are the various types of money market instruments in India.
Treasury bills
The government of India issues Treasury bills or T-bills that have a maturity period of up to 365 days and are considered to be one of the safest investment avenues in the money market. As a result, the return on these instruments is relatively lower than that of other money market instruments.
Certificates of Deposit
Scheduled commercial banks issue certificates of deposit or CDs. Like FD, they are a savings product that earn interest on lump sum for a fixed timr period. However, they do not carry the option of premature redemption and come with higher interest rates than FDs.
Repurchase Agreements
Repurchase agreements or Repos are made between two banks or between a bank and the Reserve Bank of India (RBI) to facilitate liquidity for financing short-term loans. Banks sell government securities to get short term cash and agree to buy them back at a higher price the next day under such agreements.
Commercial Papers
Highly rated companies and financial institutions issue commercial papers or CPs, which are essentially unsecured promissory notes. It enables these firms to borrow from diversified sources. CPs are generally issued at a discounted rate but redemptions happen at their face value. Investors in these CPs pocket the difference in return for carrying the limited risk till the maturity of the CP.
Investments in capital markets are made for the long term where funding is deployed for strategic, long-term business objectives. These include expansion objectives like setting up a new manufacturing plant or establishing a new supply chain. Investments in the capital markets carry more risk than those in the money markets and deliver higher potential returns. Let's look at the instruments available in this market.
Bonds with tenures of more than a year
Capital markets are not exclusively meant for equity instruments. When companies and governments issue bonds with tenures over a year, then these bonds form a part of the capital markets rather than the money markets.
Debentures
Debentures are also debt financial instruments like bonds. However, they are not secured by physical assets or any similar collateral. Hence they are riskier than bonds. Since they are riskier, they tend to carry higher interest rates than bonds. The Interest rates of debentures may be fixed or floating. Their tenures are generally lower than those of bonds. Debenture holders get preference over shareholders of a company regarding the payment of interest or dividends.
Stocks
Shares or stocks represent a unit of equity ownership in the issuing company. Shareholders are entitled to their share of profits of a company in the form of dividends. Shareholders also gain from the increased price of the shares on the exchanges. Along with the potential for high returns comes an equal downside risk as these instruments are acutely affected by market conditions.
These were some of the basic difference between the money market and the capital market summarised below:
But what if you want to invest in both these markets? Mutual funds are a convenient way to invest in both money and capital markets. You can also use your Fi account to invest in a wide range of mutual funds covering all these markets. Use FIT rules to go beyond the usual SIP or Systematic Investment Plan like, ‘When I order on Swiggy with Fi, invest ₹150 in Nifty50 index fund’.
The two types of capital markets are primary markets and secondary markets.
The primary market is where listed securities are made available to retail and institutional investors for the first time. In the primary market, securities are issued via either the Initial Public Offer (IPO) or Follow-on Public Offer (FPO) routes. IPO is a process through which an organisation can make a public offer to investors for the first time to invest in its shares.
The secondary market is called secondary because the securities here already have been issued in the primary market to initial investors. Here, the trades are between the buyer and the seller of these securities on the stock exchanges.
There is no such thing as the “best money market”. Generally, developed economies like the UK and the US tend to have very mature markets. This is because they were established earlier than those of developing economies. These markets have had time to mature over many years.
Nature of investments
Investments in the money market are generally to finance operational and tactical initiatives like paying salaries to employees on time and paying vendors on time. Whereas investments in the capital markets are generally to fund strategic, long-term initiatives like building a new manufacturing plant or setting up a new supply chain.
Tenure
Money market instruments have a tenure ranging from overnight up to a year. Capital market instruments tend to have tenures longer than a year.
Risk and Reward
Money market instruments tend to carry relatively lower risk and yield relatively lesser returns. Capital Market instruments tend to carry relatively higher risk and yield relatively higher returns over the long term.
Want to learn more about the markets? Here's some more interesting reads:
There are three instruments in the capital market, namely - Pure Instruments, Hybrid Instruments, and Derivatives.
Some examples of the instruments in money markets are Treasury Bills, Certificates of Deposits, Repurchase agreements, and Commerical Papers.
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