The key difference between the money market and capital market is that the former helps with short-term liquidity needs while the latter helps with long-term investments. They are both part of the Indian financial system; therefore, many people confuse them as similar and even use them interchangeably. However, both these markets have different foundational purposes, key players, instruments, and more. Whether you are looking to invest for the short or long term, understanding the differences in the money market vs capital market is very important.
In this article, we will discuss both these markets individually and understand the differences between them to decide which market to invest in.
What Is the Money Market?
The money market fulfills short-term liquidity needs. Investors here use it for short-term lending and borrowing, usually for less than a year. Businesses, governments, and financial institutions prefer this market to fulfill their short-term funding requirements.
Let’s try to understand this with a small example of an electronic retail company. The company is doing great business by selling computers and laptops and can cover all its operational costs from the profits generated. However, the directors decided they wanted to start a new line of products: smartphones. The company’s leaders are certain they will be able to make profits from the seasonal items but can’t meet the immediate fund requirements to buy them.
In this case, the company can borrow funds from the money market for a shorter term until it generates profits from smartphone sales. Once it starts making money, it can give back the funds borrowed with a little interest. This way, both the company and the lenders end up with a win-win situation. That’s pretty much the structure of the money market and how it operates.
Since the role of the money market is to meet short-term fund needs, it plays an important role in facilitating a smooth-functioning economy. The Reserve Bank of India (RBI) controls the money market. The RBI regulates the market, collects information about it, sets policies, and penalizes those at fault.
Types of Instruments
There are different types of money market instruments for investors to put their money in. Here are some components of the money market.
- Banker’s acceptance(BA): It is one of the safest instruments since the banks issue it, preferably for international trade. These are guaranteed by banks and they take the responsibility of paying back the investor with a certain interest rate.
- Treasury bills (T-bills): These are also short-term debt bonds facilitated and backed by the RBI and the Government of India. They are a part of the A Primer bonds and are issued in three tenures: 91 days, 182 days, and 364 days. When someone buys a treasury bill, they get it at a discounted rate, which you can then sell at the face value of ₹100 at the time of maturity. Thus, instead of interest rate, you get the difference between the discounted and face value at the end of tenure.
- Certificate of deposit (CD): Commercial banks, trusts, corporations, and even individuals issue CDs. Put simply, they are just term deposits that are negotiable but pay higher interest rates than savings accounts or fixed deposits. As a Business Standard article notes, commercial banks mobilized around ₹1.45 trillion through CDs in June 2024.
- Commercial paper: Issued by large corporations, commercial paper works similarly to T-bills but has a higher risk because it is an unsecured short-term debt. The benefit here, though, is that it offers a better interest rate than a T-bill.
- Repurchase agreements: As the name gives out, this is an agreement where one party sells securities to another with a promise to purchase it at a higher price in the future.
- Money market mutual funds: These are mutual funds that invest in various money market instruments to yield good returns over the span of one-year maturity. Most retail investors put their funds in the money market through these mutual funds.
What Is the Capital Market?
Contrary to the money market, where the investment period is within one year, the capital market offers opportunities for long-term investments. Almost all retail investors like you and me put their money in this market. There is no specific maturity period here; you can invest your money and take it back within a day or keep it invested for several years.
Let’s continue with the example of the electronic retail company to better understand the meaning of capital market and how it works. Now, for the previous example, we considered that this company was planning to sell a new line of products and took short-term funds for the same from the money market. For this situation, the money market was an ideal option because the directors were certain that they could pay back the debt within a year from the profits made by selling smartphones.
However, the directors now want to open a new branch of the store in a different city or state in India. In this case, the company will need larger capital expenditure for things like:
- Market research of the new location
- Renting or owning the new property
- Buying inventory for this store
- Hiring employees and paying their salary, etc.
To get such large capital, the company can go to angel investors or venture capitalists. However, suppose after a few years, the business is great, and the directors decide to open multiple new stores across India and even internationally. In this case, the company will have to enter the capital market to get the money required to accomplish such big plans.
As you can see in the above example, the capital market is where businesses can raise large sums of money. On the other hand, it also provides retail investors an opportunity to channel their savings to generate money quicker than the inflation rate.
A company can get listed on a stock exchange in the capital market through an Initial Public Offering (IPO). Once it gets listed on a stock exchange, it becomes a part of the stock market, which is where retail investors can buy the company’s stocks to generate profits. For instance, I can purchase the stocks of Reliance Industries Limited to gain some ownership of the company. However, it is a highly volatile market because not everyone can understand how to make money in the stock market.
While the RBI has control over both the money and capital market in India, it has declined towards the former. Therefore, the capital market is controlled and regulated by another dedicated authority: The Securities and Exchange Board of India (SEBI).
Instrument Types
Just like the money market, there are different instruments available in the capital market. Here are some of the most common ones you can invest your money in:
- Shares: Shares are equities of a company you can purchase from the stock market. These stocks are listed on the two popular stock exchanges in India: the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Therefore, these stock exchanges and the entire stock market are the most visible part of the capital market.
- Debentures: These are debt instruments issued by large corporations and government entities.
- Derivatives: These are financial contracts that change value based on an underlying asset. For example, if you buy a derivative of Mahindra & Mahindra (M&M), its value will change based on the value of the M&M stock.
- Mutual funds: You do not directly invest in mutual funds on stock exchanges. Instead, they are pooled investments that further invest the sum generated in the capital market.
- Exchange-Traded Products: Exchange-traded products (ETPs) offer a diverse range of assets from which to invest your money. They track indices, bonds, commodities, etc.
- Private equity: Instead of buying shares of an open company listed on stock exchanges, investors put their money in private companies.
Money Market Vs Capital Market: Key Differences
The table below shows the key differences between the money market and the capital market:
| Parameters | Money Market | Capital Market |
| Maturation Period | Within a year | No fixed time |
| Types of Instruments | Banker’s acceptance(BA) Treasury bills (T-bills) Certificate of deposit (CD) Commercial paper Repurchase agreements Money market mutual funds | Shares Debentures Derivatives Mutual funds Exchange-traded products Private equity |
| Liquidity | More liquid | Less liquid |
| Risk Involved | Less risk | High risk due to huge volatility |
| Returns | Low | High |
| Participants/Investors Involved | Commercial banks, financial banks, companies, central banks, CHIT funds, retail investors, etc. | Stockbrokers, insurance companies, commercial banks, underwriters, retail investors, etc. |
| Purpose | Fulfills immediate funds requirements for a short period of time | Offers stability with long-term capital needs |
| Regulators | The Reserve Bank of India | The Securities and Exchange Board of India |
| Investor’s Agenda | Preserve wealth with low risks and involvement | Generate wealth with high risks and returns |
You can also watch our YouTube video given below to learn more about the money market vs capital market:
What Is the Role of Money and Capital Markets?
The primary purpose of money and capital markets is similar to that of many other financial systems in India; they help with the cash flow. They are both important for our country’s economy and facilitate cash flow between businesses, banks, organizations, and investors.
The components of the money market, which are its instruments, provide a place for institutions and investors to park their cash safely. This is done over a shorter period of time and is less risky. On the other hand, the capital market helps channel savings into productive investments. These investments have the potential to grow wealth at a significantly high rate to help beat inflation.
Alternatives Investment Options
Investing in the Indian money and capital markets is an excellent way to become financially independent. However, these are not the only two ways to start investing. There are many alternative investment options available, including:
- Commodities
- Real estate
- Cryptocurrency
- Arts & collectibles
- Hedge funds
- Peer-to-peer lending
Deciding Which Market to Invest In
Now that you know the difference between the money market vs capital market, it is time to decide which market to invest in. The best way to decide this is by understanding which of the two markets suits your requirements better.
To begin with, banks and corporations are usually the ones playing in the money market. Retail investors can put their money here, but the only seamless way to do so is through a money market mutual fund. The capital market, on the contrary, is where most retail investors are, alongside stockbrokers, insurance companies, commercial banks, underwriters, etc. So, if you are a retail investor who wants to make their own investment decisions, the capital market will be a much better option.
Besides the fact that what types of investors invest in which market, you should also consider the risk level. The money market is highly liquid and less risky, and so it generates lower profits. However, the capital market is a highly volatile, risky market that can generate much better returns if you learn how to invest in it.
For instance, during the Diwali Muhurat Trading 2024, almost all indices ended with a 0.4% positive move. The auto and banking sectors helped with the rally, but it was also because of the positive sentiments of the investors during this session. Usually, investors see Muhurat Trading as the first stock market of the new year. Therefore, there are a lot of sentiments attached to it, which is why, in 2024, the Muhurat session ended on a positive note for the seventh consecutive time.
When to Choose the Money Market
You should choose to invest in the money market when you need some emergency fund that can grow within a year. Since it is a highly liquid market, you can easily access this fund for unexpected expenses. It is also an ideal option to achieve a short-term goal like purchasing a new car. Additionally, it is a good fit for you if you prioritize preserving your capital over potential high returns.
When to Choose the Capital Market
The capital market is the right option for investors looking to keep their money invested for the long term. This can be helpful in achieving your long-term goals like saving for your child’s college funds.
When investing in the capital market, you should be aware that there is a high risk involved. Therefore, you should learn about the instrument you are investing in before starting your journey. There are many free online resources available where you can gain basic knowledge. Being a retail investor, I have invested several years to gain the right education before starting my trading journey in the Indian stock market.
Conclusion
It is important to understand the money market vs capital market to make an informed decision. The primary difference you should be aware of between the two is that the money market helps with short-term lending and borrowing needs, whereas the capital market has no fixed maturity period. You should consider the parameters mentioned in this article, including the investors involved, risk, returns, purpose, investor’s agenda, etc., before deciding which market to invest your money in. Access your requirements and then carefully select a market that can help you achieve your financial goals.
Frequently Asked Questions
What is the difference between the money market and the capital market?
The money market is useful for short-term financial goals, and the capital market can help achieve long-term goals. While the money market is more liquid and less risky, it can yield lower returns than the capital market. However, the higher returns offered by the capital market come with higher risks.
What is the role of RBI in the money market?
The Reserve Bank of India (RBI) acts as the primary regulator of the money market. It oversees everything from the issuance of the currency, setting the interest rates, conducting open market operations, and more. In fact, it uses the interest rates of the money market as a benchmark to set the rates of other policies in India.
What is the role of SEBI in the capital market?
The role of the Securities and Exchange Board of India (SEBI) in the capital market is similar to that of the RBI in the money market. It is the regulator authority that protects the interests of the investors. It also regulates the stock market and other financial institutions.
Who is the father of the stock market in India?
While it was Premchand Roychand who established the Bombay Stock Exchange back in 1875, it was George Mathew Fernandes whose contributions helped develop and popularize it. Therefore, people commonly refer to George Fernandes as the father of the Indian stock market.
What is the nature of the capital market?
The nature of the capital market is highly volatile, especially the stock market. The volatility of the stock market can be accessed based on the VIX, which is the ticker symbol for the volatility index.
