A financial market is a link between savers and borrowers. This market transfers the money or capital from those who have surplus money to those who are in need of investment.
The investors are called surplus units and business enterprises are called deficit units. So financial market transfers money supply from surplus units to deficit units.
The financial market acts as a link between surplus and deficit units and brings together the borrowers and lenders.
Classification of Financial Market
There are two segments of the financial market:
1. Money market
2. Capital market
The money market is a market for short-term funds meant for use for a period of up to one year. Generally, the money market is the source of finance for working capital.
Transactions of the money market include lending and borrowing of cash for a short period of time and also sale and purchase of securities having one year term or which gets redeemed within one year period.
The money market is not a fixed geographical area but it constitutes all organizations and institutions which deal with short-term debts.
The common institutes are the Reserve Bank of India, State Bank of India, other Commercial banks, LIC, GIC, UTI, etc. Many of these institutions deal on phone and fax only.
Features of Money Market
- Market for short term.
- No fixed geographical location.
- Major Institutions involved in money market are RBI, commercial banks, LIC, GIC,etc.
- Common instruments of money market are call money, Treasury bill, CP, CD, Commercial bill etc.
Instruments of Money Market
1. Call Money: The money borrowed or lent on demand for a short period which is generally one day. Sundays and other holidays are excluded for this purpose. Most banks use call money. When one bank faces a temporary shortage of cash then the bank with surplus cash lends to the bank in shortage for one or two days. Call money is called interbank call money market.
2. Treasury Bills: Treasury bills are issued by the Reserve Bank of India on behalf of the Government of India. These bills enable the government to get short-term borrowings as these bills are sold to banks and the general public. These bills are negotiable instruments and are freely transferable. These are issued at a discount.
3. Commercial Bills: Trade bills or accommodation bills are bills drawn from one business firm to another. These are common instruments used in credit purchases and sales. These have a short-term maturity period generally of 90 days and can be discounted with banks even before the maturity period.
4. Commercial Paper: Commercial paper was introduced in India for the first time in 1990. It is an unsecured promissory note issued by public or private sector companies with a fixed maturity period that varies from 15 days to one year. Since commercial papers are unsecured so these can be issued by companies having a good reputation and creditworthiness. Commercial banks and mutual funds are the main investors of commercial papers.
Capital market is a market for medium and long-term funds. It includes all the organizations, institutions, and instruments that provide long-term and medium-term funds.
It does not include the instruments or Institutions which provide finance for a short period of up to one year. The common instruments used in the capital markets are shares, debentures, bonds, mutual funds, etc.
Features of Capital Market
1. Link between savers and investment opportunities: The capital market is a crucial link between the saving and investment process. The capital market transfers money from savers to entrepreneurial borrowers.
2. Deals in long-term investment: The capital market provides funds for the long and medium term. It does not deal with channelizing saving for less than one year.
3. Utilises intermediaries: The capital market makes use of different intermediaries such as brokers, underwriters, depositories, etc. These intermediaries act as working organs of the capital market and are very important elements of capital market.
4. Determinant of capital formation: The activities of the capital market determine the rate of capital formation in an economy. The capital market offers attractive opportunities to those who have surplus funds so that they invest more and more in the capital market and are encouraged to save more for profitable opportunities.
5. Government rules and regulations: The capital market operates freely but under the guidance of government policies. These markets function within the framework of government rules and regulations.
Example:- stock exchange works under the regulations of SEBI which is a government body.
Difference between Capital Market and Money Market
|S.No||Basic||Capital Market||Money Market|
|1.||Participants||The participants in the capital market of financial institutions, banks, public and private companies, foreign investors, and ordinary retail investors from public||The participants of the money market are financial institutions, banks, public and private companies but foreign and ordinary retail investors do not participate in the money market.|
|2.||Duration||The capital market deals in medium and long-term securities.||The money market deals with short-term securities having maximum tenure of one year.|
|3.||Instruments||The common instruments of the capital market are equity shares, debentures, preference shares, bonds, and other innovative securities.||The common instruments of the money market are Trade bills, CD, CP, etc.|
|4.||Liquidity||Capital market securities are considered liquid because of the stock exchange but compared to money market instruments these are less liquid.||Money market securities enjoy a higher degree of liquidity.|
|5.||Safety||The instruments of the capital market are riskier in respect to returns as well as respect to principal repayment as issuing company may fail.||The instruments of the money market are safe or less risky due to the short duration and soundness of issuers.|
|6.||Expected return||The expected return is higher in the capital market as along with regular dividends or interest there are chances of capital gain||The expected return of the money market is less due to the short duration.|
|7.||Type of Capital||Companies approach the capital market for fixed capital requirement||Companies approach the money market for the working capital requirements.|
|8.||Investment outlay||The investment in the capital market does not require huge financial investment as the value of securities is generally low.||The instruments of the money market are quite expensive so huge financial investment is required.|