Money Market vs Capital Market

The money market is for short-term liquidity, while the capital market is for long-term investments.
EXPLORE FUNDS
Money Market vs Capital Market
EXPLORE FUNDS
3 min
11-July-2024

Money markets are for meeting short-term liquidity requirements, while capital markets cater to long-term investment requirements. Money market instruments are more liquid and less risky than capital market instruments. While both play crucial roles in the operation of the economy, money markets and capital markets differ in terms of their purpose, participants, liquidity, as well as risks and returns. We cover the money market vs capital market debate in detail below.

What is a money market?

A money market is a financial market for liquid, short-term securities with a maturity tenure of less than a year. This market facilitates the quick borrowing and lending of funds, catering to the immediate cash requirement in the economy and mobilising funds from different sectors of the economy. In other words, money markets offer a platform where business and governments can obtain short-term funding to meet immediate liquidity needs.

What is a capital market?

A capital market is a financial market for long-term investments. Long-term equity or debt-backed securities like stocks, bonds, ETFs, derivatives, and mutual funds are bought and sold on such markets. Capital market investment instruments come with a maturity period of more than a year. These markets provide a platform for companies and governments to raise funds for long-term projects. Capital markets help mobilise savings for investment and fund long-term projects through trades and transactions on exchanges.

Key differences between money market and capital market

The following table outlines the key differences between money markets and capital markets across varied parameters:

Parameter Money market Capital market
Function Short-term credit facilities Long-term credit facilities
Purpose Manage short-term liquidity needs and raise working capital For long-term investing and capital accumulation geared towards expansion and growth
Participants Banks, NBFCs, corporation, government Retail investors, insurance companies, stockbrokers, underwriters, etc.
Instruments CDs, treasury bills, repurchase agreements, etc. Stocks, bonds, mutual funds, debentures, etc.
Risk and return Low risk and low returns Higher risk and potential for higher returns
Liquidity More liquid Less liquid
Maturity tenure Short-term maturity between 1 day and 1 year Long-term maturity exceeding 1 year
Mode of transaction Over-the-counter Exchange
Classification None Primary and secondary
Market nature Informal Formal and regulated

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Money Market vs Capital Market – Differences with examples

1. Definition

A money market is a short-term lending system that allows businesses to raise working capital for day-to-day operations. A capital market is geared towards long-term investment, where companies issue stocks and bonds to raise capital and expand their businesses.

2. Maturity of instruments

The maturity period for money market instruments ranges from 1 day to 1 year. Capital market instruments are long-term investments with a maturity period exceeding 1 year. Most capital market instruments may not have a stipulated maturity date.

3. Purpose served

Money market instruments are designed for short-term borrowing and lending. Firms borrow a small percentage of their overall asset base to meet immediate cash flow requirements like working capital demands. Alternatively, capital markets investments are made for long-term growth, business expansion, and capital formation.

4. Market nature

Money markets are generally informal markets, while capital markets are formal and regulated.

5. Instruments involved

Money market instruments include treasury bills, commercial papers, certificate of deposit (CD), repurchase agreements, and call & notice money. Stocks, bonds, mutual fund schemes, and ETFs are common capital market instruments.

6. Investor types

Banks, NBFCs, corporations, and governments are the key players in the money markets. These participants either wish to park their excess funds for the short-term or are looking for short-term loans to meet their immediate cash flow requirements. Companies selling stocks and bonds, retail investors buying securities, governments issuing bonds, institutional investors, and investment banks are common participants of a capital market.

7. Market liquidity

Money market instruments like CDs have a shorter maturity and can be easily converted into cash as compared to capital market instruments like stocks and bonds.

8. Risk involved

Risk is an essential component of the money market vs. capital market comparison. The short-term duration and high liquidity of money markets make them less risky than long-term and volatile capital markets.

9. Functions served

Money market aims to offer short-term liquidity to the economy, while capital markets aim to help raise long-term capital for growth and development.

10. Return on investment achieved

Money market returns are generally lower returns, but more stable than capital markets. Long-term capital market investments pose higher risks, bringing you better returns.

Examples of money market instruments

Here are a few examples of money market instruments:

  • Treasury bills
  • Certificate of deposit (CD)
  • Repurchase agreement
  • Commercial papers

Examples of capital market securities

Here are a few examples of capital market securities:

  • Equities
  • Debentures
  • ETFs
  • Derivatives

Advantages of investing in money market

Investing in money market instruments offers the following advantages:

  • Money market instruments can be easily converted into cash, ensuring easy liquidity for the investor.
  • These low-risk investments focus on short-term debt, making them relatively safer than equity stocks.
  • Money market instruments like CDs offer fixed interest rates, ensuring stable and predictable returns.
  • Investors can invest in money market instruments through banks and NBFCs, making them easy to acquire.

Advantages of investing in capital market

Investing in capital market instruments offers the following benefits:

  • Opportunity to maximise returns with investment in high-yielding securities like equity stocks.
  • Secured trading space since capital markets in India are regulated by SEBI.
  • Investors can choose from a broad range of investment options to curate a diversified portfolio and spread the overall investment risk.
  • Investment in dividend-paying instruments allows a regular and steady cash flow for the investor.

Alternatives to money markets and capital markets

A diversified portfolio works best to hedge risks associated with market volatilities. Therefore, if you are looking to diversify your investments beyond money market and capital market investments, you can also consider the following alternatives:

  • Fixed-income assets like high-yielding corporate FDs
  • Gold and other precious metals
  • Real estate
  • Collectibles

Conclusion

Before deciding between money market and capital market investments, you should carefully weigh the pros and cons of each. While money markets bring you stable, low-risk returns, they cannot match the high yield potential of capital markets. At the end of the day, as an investor you must evaluate your investment goals, time horizon, and risk appetite carefully before selecting a preference.

The mutual fund route allows you to invest in both and compound your yields. You can invest partly in money market mutual funds to enjoy the liquidity and low-risk benefits of the money market. You can balance this with equity mutual funds and their high earning potential. You can leverage the Bajaj Finserv Mutual Funds Platform to browse and compare mutual funds online and choose ones that fit your needs best.

Moreover, you can even use the SIP calculator, Step-up SIP calculator, and lumpsum calculator tools available on the platform to estimate your earnings and invest accordingly. You can contribute periodically with SIP investments or put down a lumpsum investment to start earning!

Essential tools for mutual fund investors

Mutual Fund Calculator Lumpsum Calculator Mutual Funds SIP Calculator Step Up SIP Calculator
SBI SIP Calculator HDFC SIP Calculator Nippon India SIP Calculator ABSL SIP Calculator
Tata SIP Calculator BOI SIP Calculator Motilal Oswal Mutual Fund SIP Calculator Kotak Bank SIP Calculator

Frequently asked questions

What is the difference between a money market and capital market?
The main difference between money and capital markets is the duration of investment and risk component. Money markets consist of short-term investments carrying less risk, while capital markets are long-term focused and carry a greater risk and higher potential for gains/losses.
What is the difference between the financial market and the capital market?
A financial market is one where trades relating to financial assets take place, while a capital market is one where companies and the government can raise long-term capital.
What is the difference between an equity and money market?
An equity market trades in stocks and aims to offer higher returns through capital appreciation. A money market handles short-term investments, focusing on liquidity, thus, generating lower returns against a reduced investment risk.
What is an example of a money market?
Money markets include markets for T-bills, CDs, money market mutual funds, commercial papers, and repurchase agreements.
What is a capital market example?
Examples of a capital market is the BSE or Bombay Stock Exchange where stocks, bonds, and other long-term securities are traded.
What is the role of the capital market?
Risk diversification and price determination are the primary roles of a capital market.
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