Financial Markets

A financial market is a place where buyers and seller come together to trade in financial assets such as bonds, stocks, derivatives, currencies and commodities. The main objective of a financial market is to fix prices for global trade, increase capital and transfer risk and liquidity. Financial market has various components; the two most important components are the money market and capital market. In the money market, only short-term liquid financial instruments are exchanged. Whereas, in the capital market, only long term securities are dealt with.

Money Market

The money market is a component of the economy which provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods, typically up to twelve months. Money market trades in short-term financial instruments commonly called “paper”. The money market is referred to as dealing in debt instruments with less than a year to maturity bearing fixed income. In this article, we will cover the meaning of money market instruments along with its types t.and objectives Money Market is a financial market where short-term financial assets having liquidity of one year or less are traded on stock exchanges. The securities or trading bills are highly liquid. Also, these facilitate the participant’s short-term borrowing needs through trading bills. The participants in this financial market are usually banks, large institutional investors, and individual investors

Money market is a safe place to invest due to the high liquidity of security. Withdrawing money from money market is easier. There are a variety of instruments traded in the money market in both the stock exchanges, NSE and BSE. These include treasury bills, certificates of deposit, commercial paper, repurchase agreements, etc. Since the securities being traded are highly liquid in nature, the money market is considered as a safe place for investment. The Reserve Bank controls the interest rate of various instruments in the money market. The degree of risk is smaller in the money market. This is because most of the instruments have a maturity of one year or less. Hence, this gives minimal time for any default to occur. The money market thus can be defined as a market for financial assets that are near substitutes for money.

Term: Short-term financial tools are being settled is referred to as Money Market.

Instruments involved: Commercial Papers, Treasury Certificate of Deposit, Bills, Trade Credit, etc.

Investor Types: Commercial banks, non-financial institutions, central bank, chit funds, etc.

Market Nature: Money markets are informal in nature.

Liquidity: Money markets are highly liquid.

Risk Involved: Money markets have low risk.

Purpose: To achieve short term credit requirements of the trade.

Functions: Stabilizing economy by increase in savings.

Return on investment: ROI is usually low in money market.

What is the importance of the money market?

The money market is a market for short term transactions. Hence it is responsible for the liquidity in the market. Following are the reasons why the money market is essential:

1. It maintains a balance between the supply of and demand for the monetary transactions done in the market within a period of 6 months to one year.
2. It enables funds for businesses to grow and hence is responsible for the growth and development of the economy.
3. It aids in the implementation of monetary policies.
4. It helps develop trade and industry in the country. Through various money market instruments, it finances working capital requirements. It helps develop the trade in and out of the country.
5. The short term interest rates influence long term interest rates. The money market mobilises the resources to the capital markets by way of interest rate control.
6. It helps in the functioning of the banks. It sets the cash reserve ratio and statutory liquid ratio for the banks. It also engages their surplus funds towards short term assets to maintain money supply in the market.
7. The current money market conditions are the result of previous monetary policies. Hence it acts as a guide for devising new policies regarding short term money supply.
8. Instruments like T-bills, help the government raise short term funds. Otherwise, to fund projects, the government will have to print more currency or take loans leading to inflation in the economy. Hence the money market is also responsible for controlling inflation.

What is the purpose of the money market?

Money market maintains liquidity in the market. RBI uses money market instruments to control liquidity. It finances short term needs of the government and economy. Any business or organization can borrow money at short notice for a short term. Helps in utilizing surplus funds in the market for a short term to earn an additional return. It channelizes savings to investments. Assists in mobilizing funds from one sector to another with the utmost transparency Guides in devising monetary policies. The current money market conditions are the result of previous monetary policies. Hence it acts as a guide for devising new policies regarding short term money supply.

Capital Market:

Capital market is the market that helps the companies in raising long term investment credit. It is the market for long term funds. It refers to all the facilities and institutional arrangement for borrowing and lending term funds.  It does not deal in capital goods but it is concerned with raising of money capital for purpose of investment.

Term: Long-term finance to coincide with the capital necessary is called Capital Market.

Instruments involved: Bonds, Debentures, Shares, Asset Securitization, Retained Earnings, Euro Issues, etc.

Investor Types: Stockbrokers, insurance companies, Commercial banks, underwriters, etc.

Market Nature: Capital markets are formal in nature.

Liquidity: Capital markets are comparatively less liquid.

Risk Involved: Capital markets are riskier in comparison to money markets.

Purpose: To achieve long term credit requirements of the trade.

Functions: Increasing liquidity of funds in the economy.

Return on investment: ROI is comparatively high in capital market

Significance of Capital Market in economic development:

1-Mobilization of Savings: Mobilizes savings through various instruments but also channelizes them into productive avenues. Thus, capital market mobilizes these savings and make the same available for meeting the large capital needs of industry, trade and business.

2-Channelization of Funds into Investment: Capital market plays a crucial role in the economic development by channelizing funds in accordance with development priorities.

3-Industrial Development: It provides funds for diversified purposes such as for expansion, modernization, up gradation of technology, establishment of new units etc.

4-Modernization and Rehabilitation of Industries: The setting up of development financial institutions in India such as IFCI, ICICI, IDBI and so on has helped the existing industries in the country to adopt modernization and replacement of obsolete machinery by providing adequate finance.

5-Technical Assistance: By offering advisory services relating to the preparation of feasibility reports, identifying growth potential and training entrepreneurs in project management.

6-Encourage Investors to invest in Industrial Securities: Secondary market in securities encourage investors to invest in industrial securities by making them liquid. It provides facilities for continuous, regular and ready buying and selling of securities

7-Reliable Guide to Performance: The capital market serves as a reliable guide to the performance and financial position of corporate, and thereby promotes efficiency.

What is the difference between the money market and capital market?

• The money market is the component of a financial market that deals with short term borrowings. On the other hand, the capital market is also a component of the financial market that allows long term trading of equity and debt securities.
• Money markets deal in short term lending, borrowing, buying and selling. In contrast, capital markets deal in long term lending or borrowing. Corporations or investors with sizeable investible amount deal in capital markets. Financial regulators are responsible for overseeing the capital market activities. Their role is to ensure that companies do not default investors.
  Businesses are seeking to fulfil short term credit requirements go-to money market. In comparison, capital markets meet the long term financial needs of the business.
• Capital markets offer highly volatile instruments. On the other hand, the money market offers comparatively, safer assets.
• Returns from capital markets are comparatively higher. The returns from capital markets correlate with the volatility (level of risk). However, this is not always the case. Returns from money market instruments are low but steady.
• Maturity of money market instruments is usually up to one year. At the same time, the maturity of capital markets instruments is longer. They don’t have a specific time frame.