Money Market Vs. Capital Market: An Overview
The money market and the capital market are not single institutions but two broad components of the global financial system.
- The money market is the trade in short-term debt. It is a constant flow of cash between governments, corporations, banks, and financial institutions, borrowing and lending for a term as short as overnight and no longer than a year.
- The capital market encompasses the trade in both stocks and bonds. These are long-term assets bought by financial institutions, professional brokers, and individual investors.
Together, the money market and the capital market comprise a large portion of what is known as the financial market.
Financial Markets: Capital vs. Money Markets
The Money Market
The money market is a good place for individuals, banks, other companies, and governments to park cash for a short period of time, usually one year or less. It exists so that businesses and governments that need cash to operate can get it quickly at a reasonable cost, and so that businesses that have more cash than they need can put it to use.
- 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.
The returns are modest but the risks are low.
The instruments used in the money markets include deposits, collateral loans, acceptances, and bills of exchange. Institutions operating in the money markets include the Federal Reserve, commercial banks, and acceptance houses.
When a company or government issues short-term debt, it's usually to cover routine operating expenses or supply working capital, not for capital improvements or large-scale projects.
The money market plays a key role in ensuring that banks, other companies, and governments maintain the appropriate level of liquidity on a daily basis, without falling short and needing a more expensive loan and without hoarding excess cash that isn't earning interest.
Individual investors may use the money markets to invest their savings in a safe and accessible place. Many choices are available, including mutual funds that focus on state money market funds, municipal funds, and U.S. Treasury funds. Many of the government funds are tax-free. A money-market fund also can be opened at most banks.
The Capital Market
The capital market is where stocks and bonds are traded. Its movements from hour to hour are constantly monitored and analyzed for clues to the health of the economy at large, the status of every industry in it, and the consensus for the short-term future.
The overriding goal of the companies institutions that enter into the capital markets is to raise money for their long-term purposes, which usually come down to expanding their businesses and increasing their revenues. They do this by issuing stock shares and by selling corporate bonds.
Primary and Secondary
The capital market is roughly divided into a primary market and a secondary market. A company that issues a round of stock or a new bond places it in the primary market for sale directly to investors or institutions. If and when those buyers decide to sell their shares or bonds, they do so on the secondary market. The original issuer of those stocks or bonds does not immediately benefit from their resale, although companies certainly have an interest in the price of their stock shares rising over time.
The capital market is by nature riskier than the money market and has greater potential gains and losses.