Money Market

Financial instruments such as deposits, loans, and assets with high liquidity and short maturities are exchanged on the money market (MM). Governments, financial institutions, and large enterprises issue MM instruments.

Many participants, including businesses, use it to raise money by peddling commercial papers in the marketplace. Due to the high liquidity of the securities, it is seen as a secure area to invest.

One of the key objectives of the MM is to enable large corporations with surplus short-term excess cash to invest that capital in short-term money market instruments.

Generally, money markets have five purposes: 

• Finance trade
• Finance the industry
• Invest productively
• Increase the self-sufficiency of commercial banks
• Smooth out central bank policies.

Many banks engaged in lending to each other, and major firms through the time deposit and Eurocurrency markets are examples of institutions participating in it.

Businesses with immediate liquidity needs can sell assets like commercial paper or take out short-term loans.

A MM mutual fund, a managed fund that is run professionally and is also used to invest in various MM products, is a good place for smaller businesses with extra cash. Larger firms typically join directly through their dealer.

Every nation with its monetary system must have some sort of market where short-term credit providers can trade goods and services. 

Such facilities are required in much the same manner that they are required for the retail distribution of any of the final customers of the products of a diversified economy. 

Types of Instruments Traded in the Money Market

Money market instruments come in 13 different varieties. Each one satisfies the unique requirements of various consumers. To meet their financial demands, certain businesses may use a variety of different MM accounts.

Some are intended for banks and other significant financial institutions, while others are business-oriented.

1. Commercial Paper

Large businesses with excellent credit can easily raise money by issuing short-term unsecured promissory notes. A derivative of commercial paper is asset-backed commercial paper. 

2. Federal Funds

The only companies that use federal funds are banks. Each night, banks employ them to satisfy the Federal Reserve requirement, representing 10% of all bank liabilities exceeding $58.8 million are represented by it.

3. Discount Window 

A bank may use the Fed's discount window if it cannot borrow federal funds from another bank. The Fed purposefully sets its discount rate slightly above the Fed funds rate. It favors banks borrowing from one another. 

4. Certificate of Deposit (CD)

To raise capital on a short-term basis, banks offer certificates of deposit. They can last anywhere from one and six months. The longer the cash is held, the higher the interest rate the CDs pay the bearer.

5. Eurodollars 

Banks can also issue CDs in foreign institutions. Instead of dollars, euros are used to hold these. 

6. Repurchase Agreements 

A "repo" is when a bank offers securities while simultaneously pledging to repurchase them at a higher price. 

This frequently indicates the following day with a bit more intrigue. It is recorded as a short-term collateralized loan even though it is a sale. The security's buyer, who is actually the lender, carries a reverse repo. 

7. Swaps

A swap is an agreement between two parties to exchange all upcoming loan interest payments. The underlying value of the two streams of interest payments is used to determine the swap's worth.

The majority of swaps are based on bonds that have varying interest rates due over time. Investors can use swaps to reduce the risk associated with future interest rate changes.

8. Backup Line of Credit 

The backup line of credit is a quick-term note that safeguards a company's investors. In this case, if the issuer defaults, a bank will guarantee to pay 50% to 100% of the MM instrument.

9. Credit Enhancements 

In the event that the issuer does not redeem the MM instrument, the bank releases a letter of credit promising to do so. 

10. Treasury Bills

The federal government issues Treasury bills to raise money. They only last for a year or less. 

11. Municipal Notes

Cities and states issue short-term municipal bonds to raise funds. 

12. Futures Contracts 

Traders are required under futures contracts to purchase or sell a money market security at a predetermined price on a specified date in the future. Treasury bills, interest swaps, eurodollars, and a 30-day average of the fed funds rate are the four instruments that are frequently employed.

13. Futures Options

Additionally, traders can buy a MM futures contract at a certain price on or before a given date, but they are not obligated to do so. For instance, 5-, 10-, and "ultra" 10-year Treasury notes are available with Treasury options.

What is Capital Markets?

The area of the financial market designated for trading long-term debt securities is known as the capital market.

The capital market allows participants to raise money by issuing bonds, stocks, and other long-term instruments. Investors in these debt products participate in the capital market as well.

The primary and secondary markets are additional divisions of the capital market. This is how they contrast:

1. The primary market

New stock and bond issuances are first offered to investors in the primary market. A primary market transaction is an initial public offering or IPO.

2. The secondary market 

Securities already issued are traded between investors on the secondary market. This transaction does not necessarily involve the company that issued the stocks or bonds.

You can gain as an investor by purchasing and selling stocks on the capital market. You might be able to sell your stocks for a capital gain if their value increases. Stocks that provide dividends are another source of current income.

The capital market facilitates the raising of funds for businesses and other entities. Publicly traded stocks, bonds, and other securities are traded on stock exchanges. The capital market is generally well-organized. 

Companies that issue stocks are engaged in long-term capital raising that can be used to support ongoing operations, growth and expansion initiatives, or both. Liquidity, length, and risk often differentiate capital investments from money market investments. 

Money Markets Vs Capital Markets

There are significant differences between the money and capital markets when comparing them. Understanding the major distinctions between money markets and capital markets will help you comprehend them more fully.

1. Purpose

What each market intends to do may be the biggest distinction between money and capital markets. The MM is used for lending and borrowing on very short terms. It serves as a source of short-term credit for businesses, offering relatively safe investments with limited growth potential.

On the other hand, the capital market was created to support firms and companies with their credit needs. However, the focus is on medium- to long-term requirements. Although they carry greater risk than the MM, the capital markets could yield higher returns.

2. Length of Securities

Short-term securities, often with a maturity duration of one year or less, are traded on it. 

The term "maturity period" refers to a period of time that is typically not fixed in the capital market. 

3. Financial Instruments 

As previously indicated, bankers’ acceptances, certificates of deposit, commercial paper, and treasury bills are among the financial products exchanged in the short-term MM. The capital market trades stocks, bonds, and other long-term securities.

4. Nature of the Market 

It is typically informal and weakly organized in terms of structure and organization. Securities may be exchanged outside of a stock exchange or over the counter. 

In the capital market, exchanges are primarily used for trading. Overall, this market is more formalized and organized.

5. Securities Risk 

When choosing where to invest your money, risk must be considered. The risk attached to the financial instruments traded in the MM is smaller because its nature tends toward shorter-term transactions. The capital market, on the other hand, can present investors with increased risk.

6. Liquidity 

A measure of liquidity is how simple it is to turn an asset into cash. The MM generally provides higher liquidity, a major distinction between capital and money market investments. This implies that if you need to sell an investment swiftly, the MM will give you a better chance.

7. Return on Investment (ROI) 

How straightforward it is to convert an asset into cash serves as a gauge of liquidity. A key distinction between capital investments and MM investments is that MM typically offers more liquidity. 

Reviewed and edited by Parul Gupta | LinkedIn

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