Money Market Vs Capital market?

The money and capital markets are fundamental to the economy, with both
serving essential purposes for investors and businesses. Understanding the
difference between these markets is crucial for investors, businesses, and
anyone looking to navigate the complex landscape of modern finance.
The money market deals in short-term debt instruments, typically on a
timeline of one year or less. It's where governments, banks, and large
corporations go to manage their immediate cash needs. Meanwhile, the
capital markets involve long-term securities, such as stocks and bonds, that
mature in more than one year. This is where companies and governments
raise funds for major projects and long-term growth.
KEY TAKEAWAYS
 The money market is a short-term lending system. Borrowers tap it for
the cash they need to operate from day to day. Lenders use it to put
spare cash to work.
 The capital market is geared toward long-term investing. Companies
issue stocks and bonds to raise money to grow their businesses.
Investors buy them to share in that growth.
 The money market is less risky than the capital market while the
capital market is potentially more rewarding.
 Both markets are subject to comprehensive regulation to ensure
transparency, fairness, and stability.
Money markets are the lifeblood of day-to-day financial operations, while
capital markets sustain long-term economic growth. They differ in three key
aspects: the types of financial instruments traded, the duration of
investments, and the level of risk involved. While the money market
prioritizes liquidity and safety, the capital market offers the potential for
higher returns with increased risk. Below, we'll explore each market's
characteristics, what's traded on them, and how they work together to
keeps the economy moving.
What Is the Money Market?
The money market is for short-term lending and borrowing, usually for a
year or less. It’s like a fast lane where businesses, governments and
financial institutions can get their quick funding needs met. Thus, it is
important for liquidity management. This market is known for its high
liquidity, generally low risk, and ease of access to capital.
The money market works through instruments like commercial
paper, Treasury bills, and certificates of deposit. These instruments facilitate
quick fund transfers and help to stabilize interest rates. They are often
regarded as a safe haven for investors to park their surplus cash and keep
the system liquid and stable.
How Does the Money Market Work?
In the money market, banks, corporations, and government entities buy and
sell financial instruments to manage liquidity. These transactions involve
instruments like T-bills and commercial paper where terms are shorter and
settlement is quick. This fast-paced activity helps participants to manage
their short-term funding needs.
Money market operations are crucial for the level of liquidity and interest
rates in the economy. They provide quick access to cash and stabilize
interest rates so they are more predictable. The quick turnaround of funds
allows investors to park their money temporarily and supports monetary
stability.
Types and Examples of Money Markets
Money markets play a crucial role in the financial system, providing a place
for institutions and individuals to park cash safely for short periods. These
markets deal in highly liquid, short-term debt instruments, typically with
maturities of one year or less.
The money market is far broader than money market funds or accounts
available at banks and other financial institutions. While related, the latter is
a mutual fund that invests in high-quality, short-term debt instruments and
cash equivalents. Many are also insured by the Federal Deposit Insurance
Corporation (FDIC).
i. Government Funds
Government money market funds primarily invest in short-term securities
issued by the government, such as Treasury bills and other government-
backed instruments. They are considered very safe and liquid, offering a
lower yield but greater security compared with prime funds.
 Treasury Bills (T-Bills)
 The safest money market instrument, T-bills are short-term debt
obligations backed by the government.
 They're sold in denominations of $1,000 up to a maximum of $5
million and have maturities of 4, 8, 13, 26, or 52 weeks. Maturity
refers to the date when an investment reaches the end of its preset
term, when any principal and accrued interest or returns are paid to
an investor.
 Investors buy T-bills at a discount from their face value and receive the
full face value when they mature, with the difference representing the
interest earned.
NB: Treasury notes and bonds are not included here as bonds and other
fixed-income instruments with longer terms are considered part of the
capital markets.
 Re-purchase Agreements(Repos)
 Repos involve the sale of securities with an agreement to repurchase
them at a slightly higher price on a specific future date, often the next
day.
 They're essentially short-term loans, typically used by dealers in
government securities. The securities serve as collateral, making repos
relatively low-risk.
ii. Prime Funds
 Commercial Paper
  Commercial paper consists of unsecured, short-term debt issued by
large corporations to fund day-to-day operations.
 These instruments typically mature within 270 days and are issued at
a discount to face value.
 While riskier than T-bills, commercial paper from top-rated companies
often offers slightly higher yields.

 Certificates of Deposit (CDs)

 CDs have fixed terms ranging from a few weeks to several years and
pay higher interest rates than standard savings accounts, though the
depositor has to wait a period to obtain the funds back.
 NB: Not all CDs fall within the money market category; those
with maturities greater than one year are not part of the
money market.
 CDs come in a variety of terms from three, six, or 12 months
to four, five, and 10-year terms. Once they have over a one-
year term, CDs are considered part of the capital markets.
 Bankers' Acceptances
These are short-term debt instruments guaranteed by a bank, often used for
international trade. When a bank "accepts" a bankers' acceptance, it
assumes responsibility for paying the holder when the instrument matures.
This bank guarantee makes them relatively safe investments.
 Corporate Bonds (Short Term)
For inclusion in the money market, the type of short-term corporate bonds
counted here has maturities of one year or less. This is debt issued by
companies that offer a way for corporations to borrow money from investors
for relatively brief periods, often to fund operations, finance projects, or
refinance existing debt.
The highest quality (and safest, lower yielding) bonds are commonly
referred to as "Triple-A" bonds, while the least creditworthy are termed
"junk."
iii. Tax-Exempt Funds
 Municipal Bonds (Munis)
Tax-exempt money market funds are primarily municipal bonds or notes,
which are issued by state and local governments. These are often tax-
exempt at the federal level, making them attractive to investors in high tax
brackets.
The chart below shows the $6.57 trillion U.S. money market broken down
under the main headings used here:

What is the Capital Market?

 In the capital markets, transactions are mostly driven by the buying
and selling of long-term financial instruments like stocks and bonds.
 Investors buy these from issuers in primary markets or trade them in
secondary markets.
 This helps companies and governments get the funds they need for
various projects and objectives.
 Buyers (investors) hope to get returns through dividends or interest
and potential appreciation in value.
 These transactions involve matching buyers with sellers through
exchanges or over-the-counter (OTC) platforms.
 Brokers and dealers play a key role in facilitating transactions and
keeping things smooth.
 Pricing in the capital markets is driven by supply and demand,
investor sentiment, and economic indicators.
Types and Examples of Capital Markets
The capital markets can be broken down into the primary and secondary
markets. The primary market is where new securities (for instance, an initial
offering of equities or bonds) are sold for the first time, such as when a
company sale shares to public with an initial public offering (IPO). This
allows companies to raise capital directly from investors who buy these new
shares (Eg.Ethio Telecom share sales via IPO)
In the secondary market, investors trade securities that have already been
issued, exchanging them with one another, such as on the New York Stock
Exchange (NYSE). Another type of capital market is the derivatives
market, where financial contracts, like futures and options, are traded.
Often, these contracts are based on so-called underlying assets, such as
specific stocks or commodities.
The biggest exchange in the world is the New York Stock Exchange,
representing over $28 trillion in market capitalization.

i. Primary Markets
The primary markets are where new securities are first issued and sold to
investors. This is where companies, governments, and others raise capital
by selling stocks, bonds, or other financial instruments directly to investors.
Equity Securities in Primary Markets
In the primary equity market, companies offer ownership stakes to the
public for the first time through IPOs. This process allows private companies
to become publicly traded. Companies can also conduct follow-on offerings,
issuing additional shares to raise more capital after their IPO. For a more
selective approach, private placements allow companies to sell shares
directly to a limited number of investors, often institutional buyers or
accredited individuals.
Debt Securities in Primary Markets
The primary debt market is where entities borrow money by issuing bonds.
Corporations issue corporate bonds to fund operations or expansion.
Governments at various levels participate too: the federal government
issues Treasury securities, and states and cities offer municipal bonds to
finance public projects.
Hybrid Securities in Primary Markets
Bridging the gap between stocks and bonds, hybrid securities offer features
of both. Convertible bonds start as debt but can be converted into stock
under certain conditions. Preferred stock, another hybrid, typically offers
fixed dividends like bonds but represents ownership like common stock.
ii. Secondary Markets
The secondary markets are what investors are far more familiar with, since
it's where they trade previously issued securities.
Equity Markets
Stock exchanges like the NYSE and Nasdaq are the most visible part of
secondary markets. Here, public companies' stocks trade hands rapidly.
Beyond these major exchanges, over-the-counter OTC markets handle
trades in smaller or less liquid stocks. Dark pools, private exchanges for
trading securities, allow large institutional investors to make big trades
without immediately impacting the public market price.
Bond Markets
The secondary bond market is vast. Government bond markets trade
Treasury securities, crucial in setting benchmark interest rates. Corporate
bond markets allow investors to trade in company debt, while municipal
bond markets focus on state and local government debt. The MBS market
trades in securities backed by pools of mortgages.
Mutual Funds
Though not directly traded on exchanges, mutual funds represent pooled
investments for individuals and others who buy and sell shares in the fund
itself, which typically hold a diversified portfolio of stocks, bonds, or other
securities.
Exchange-Traded Products
Exchange-traded funds (ETFs) and exchange-traded notes (ETNs) are
securities that track indexes, commodities, bonds, or baskets of assets.
They trade on exchanges like stocks, offering investors a way to gain
exposure to a diverse range of assets with the ease of stock trading.
Derivatives Markets
Derivatives are financial contracts whose value is derived from underlying
assets:
 Options markets trade contracts giving the right (but not obligation) to
buy or sell assets at predetermined prices.
 Futures markets deal in agreements to buy or sell assets at a future
date.
 Swaps markets enable the exchange the cash flows or liabilities from
two different financial instruments between two parties.
Alternative Investments Available Through the Capital Markets
This category includes a range of nontraditional investments. For example,
real estate investment trusts have shares that trade on the exchanges and
allow investors to invest in portfolios of real estate assets. Hedge funds use
a variety of complex strategies to generate returns. Venture capital focuses
on investing in startup companies with high growth potential.
Differences Between Money Market and Capital Market
Money Market
 Duration: Shorter-term instruments, often with maturities less than a
year, focus on liquidity and quick returns.
 Instruments: Treasury bills, commercial paper, certificates of deposit
for short-term borrowing and lending.
 Risk: Lower risk because of short-term nature and high credit quality
of instruments.
 Purpose: For managing short-term funding needs and liquidity in the
financial system
Capital Market
 Duration: Longer-term investments, securities like stocks and bonds
with maturities more than a year.
 Instruments: Mostly equities, bonds, derivatives.
 Risk: Higher risk because of longer maturities and market volatility but
potentially higher returns.
  Purpose: For capital formation by channeling savings into long-term
productive investments, for economic growth.
Which Market Should You Invest In?
When choosing between the capital and money markets, consider your
investment goals and time frame.
 If you’re looking for shorter-term, low-risk investments with quick
returns, the money market is probably the way to go. Its instruments,
like Treasury bills, are designed to preserve capital and provide
liquidity over shorter periods.
 However, most individual investors will be looking to the longer-term
capital markets. Investing in stocks or bonds can build wealth over
time and align with your long-term financial goals and higher
tolerance for market fluctuations.
Alternatives to Money and Capital Markets
While traditional money and capital markets play a crucial role in the
financial system, alternative investment vehicles and markets are also an
important element of the financial system. These alternatives often appeal
to investors seeking diversification, potentially higher returns, or alignment
with specific values or needs. Here are some of the main alternatives:
1. Cryptocurrency Markets
Cryptocurrencies like Bitcoin and Ether are a digital alternative to traditional
currency and investment markets. Operating on decentralized blockchain
technology, these digital assets offer potential benefits such as increased
transaction privacy and speculative returns. However, they also come with
significant volatility and regulatory uncertainty.
2. Real Estate
Direct investment in properties provides an alternative to the capital and
money markets. Real estate can offer steady income through rent and
potential capital appreciation, though it comes with its own risks and often
requires significant capital.
3. Private Equity
Private equity simply called venture capital, is a different approach to
investing in shares of companies and other investments. Instead of trading
shares of public companies in an open market, investors may seek
alternative avenues to put capital into private companies or startups.
Peer-to-Peer Lending
In recent years, online platforms have enabled individuals to lend directly to
other individuals or small businesses, bypassing traditional banking
systems. This can offer higher returns for lenders and lower rates for
borrowers but also increases the risk of default.

Commodities
Investing directly in physical commodities like gold, oil, or agricultural
products offers a way to diversify beyond financial instruments. These
investments can serve as a hedge against inflation but can be subject to
significant price swings.Futures and other derivatives based on the value of
commodities are available through the capital markets.
Art and Collectibles
High-value art, rare coins, vintage cars, and other collectibles represent an
alternative market that some investors use to diversify their portfolios.
While potentially lucrative, these markets require specialized knowledge and
can be highly illiquid.

Money and Capital Markets at a Glance

 Security/ Descriptio Investor Risk Liquidi
Market Instrument n Type Level ty

Investments in
High-net-
high-value art
Alternative Art and Collectibles worth High Low
pieces or rare
individuals
collectibles.
 Security/ Descriptio Investor Risk Liquidi
Market Instrument n Type Level ty

Short-term
debt
Money guaranteed by Institutions,
Bankers' Acceptances Low Medium
Market a bank, often corporations
used in trade
finance.

Fixed-term Low
deposits
Conservative
Certificates of Deposit offered by
investors, Low
(CDs) banks, with
retirees
fixed interest
rates.

Short-term
Institutions,
corporate
Commercial Paper money Low Medium
debt, often
market funds
unsecured.

Physical goods
such as gold,
Institutions,
Commodities oil, or High Medium
speculators
agricultural
products.

Bonds that can

be converted
Capital Risk-tolerant Medium to
Convertible Bonds into stock, Medium
Market investors High
offering upside
potential.

Corporate Bonds Debt securities Conservative Medium Medium

issued by investors, (depends
companies. institutions on credit
 Security/ Descriptio Investor Risk Liquidi
Market Instrument n Type Level ty

rating)

Digital or
virtual
Risk-tolerant
currencies
Cryptocurrencies investors, Very High High
using
speculators
cryptography
for security.

Baskets of Medium
securities that Individual (depends
ETFs (Exchange-
trade like investors, on High
Traded Funds)
stocks on an institutions underlying
exchange. assets)

Contracts to
buy or sell an
asset at a Traders,
Futures High High
future date at hedge funds
an agreed
price.

Low to
Debt securities Conservative
Medium
Government Bonds issued by investors, High
(depends
governments. institutions
on issuer)

Pooled
investments Accredited
Hedge Funds using varied investors, High Low
and complex institutions
strategies.

Money Market Funds that Conservative Low High

 Security/ Descriptio Investor Risk Liquidi
Market Instrument n Type Level ty

invest in highly
liquid, short- investors,
Mutual Funds
term institutions
instruments.

Pooled
investment
vehicles Individual
Mutual Funds managed by investors, Medium Medium
professionals, retirees
offering
diversification.

Derivatives
giving the right
(but not Traders,
Options High High
obligation) to institutions
buy/sell a
security.

Hybrid of
bonds and Income-
stocks, offering seeking
Preferred Stock Medium Medium
fixed dividends investors,
but no voting institutions
rights.

Investments in Institutions,
Private Equity privately-held accredited High Low
companies. investors

Investments in Income
REITs (Real Estate
real estate investors, Medium Medium
Investment Trusts)
portfolios. retirees
 Security/ Descriptio Investor Risk Liquidi
Market Instrument n Type Level ty

Short-term
Repurchase loans secured
Institutions Low High
Agreements (Repos) by government
securities.

Shares of
ownership in a
High
company.
Individual (especially
Investors earn
Stocks (Equities) investors, for High
through
institutions individual
dividends and
stocks)
price
appreciation.

Short-term
Conservative
debt securities
Treasury Bills (T-Bills) investors, Low High
issued by
institutions
governments.

Who are the members of money market?

The major participants in the money market are commercial banks,
governments, corporations, government-sponsored enterprises, money
market mutual funds, futures market exchanges, brokers and dealers, and
the Federal Reserve. Commercial Banks Banks play three important roles in
the money market.
Objectives of money market?
To provide lenders with sufficient liquidity due to short-term securities.
To enable lenders to convert idle funds into profitable investments.
To follow the rules and regulations of Government and authoritative bodies.
To control and regulate the level of liquidity in the economic system.
What are the risks of money market?
There are two main types of liquidity risks faced by money market funds:
funding liquidity risk (if the fund's liquidity is insufficient to meet
redemptions) and market liquidity risk (if market volatility forces funds to sell
securities below the mark-to-market price in order to meet large
redemptions or maintain ...
What are the disadvantages of money market?
Some disadvantages are low returns, a loss of purchasing power, and the
lack of FDIC insurance. A money market fund can be ideal in some situations
and potentially unwise in others.
How does the money market account work?
When you open a money market account, your bank or credit union typically
offers you interest measured with annual percentage yield (APY). Money
markets typically have a variable interest rate, meaning the rate may rise or
fall, influenced by market interest rates and other factors.
What role does the money market play?
The role of money markets is to keep the financial gears running smoothly
by handling short-term borrowing and lending, setting prices for financial
stuff, managing liquidity (making sure there's enough cash flow), supporting
trade and commerce, and helping banks manage their reserves.22-