Professional Documents
Culture Documents
Money market is distinguished from capital market on the basis of the maturity period,
credit instruments and the institutions:
1. Maturity Period: The money market deals in the lending and borrowing of short-term
finance (i.e., for one year or less), while the capital market deals in the lending and borrowing of
long-term finance (i.e., for more than one year).
2. Credit Instruments: The main credit instruments of the money market are call money,
collateral loans, acceptances, bills of exchange. On the other hand, the main instruments used in the
capital market are stocks, shares, debentures, bonds, securities of the government.
3. Nature of Credit Instruments: The credit instruments dealt with in the capital market are
more heterogeneous than those in money market. Some homogeneity of credit instruments is
needed for the operation of financial markets. Too much diversity creates problems for the
investors.
4. Institutions: Important institutions operating in the' money market are central banks,
commercial banks, acceptance houses, nonbank financial institutions, bill brokers, etc. Important
institutions of the capital market are stock exchanges, commercial banks and nonbank institutions,
such as insurance companies, mortgage banks, building societies, etc.
5. Purpose of Loan: The money market meets the short-term credit needs of business; it
provides working capital to the industrialists. The capital market, on the other hand, caters the
long-term credit needs of the industrialists and provides fixed capital to buy land, machinery, etc.
6. Risk: The degree of risk is small in the money market. The risk is much greater in capital
market. The maturity of one year or less gives little time for a default to occur, so the risk is
minimised. Risk varies both in degree and nature throughout the capital market.
7. Relation with Central Bank: The money market is closely and directly linked with central
bank of the country. The capital market feels central bank's influence, but mainly indirectly and
through the money market.
8. Market Regulation: In the money market, commercial banks are closely regulated. In the
capital market, the institutions are not much regulated.
Bankers' Acceptances
A bankers' acceptance (BA) is a short-term credit investment created by a non-financial
firm and guaranteed by a bank to make payment. Acceptances are traded at discounts from face
value in the secondary market. It is document indicating that such-and-such bank shall pay the face
amount of the instrument at some future time. The bank accepts this instrument, in effect acting as
a guarantor. To be sure the bank does so because it considers the writer to be credit-worthy.
Bankers' acceptances are generally used to finance foreign trade, although they also arise when
companies purchase goods on credit or need to finance inventory. The maturity of acceptances
ranges from one to six months.
Repurchase Agreements
Repo is short for repurchase agreement. Those who deal in government securities use repos as
a form of overnight borrowing. A dealer or other holder of government securities (usually T-bills)
sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed
price. They are usually very short-term, from overnight to 30 days or more. Repos are popular
because they can virtually eliminate credit problems. There are also variations on standard repos:
Reverse Repo - The reverse repo is the complete opposite of a repo. In this case, a dealer
buys government securities from an investor and then sells them back at a later date for a
higher price
Term Repo - exactly the same as a repo except the term of the loan is greater than 30 days.
What's the difference between a bank guarantee (bankers’ acceptance) and a letter of
credit?
A letter of credit is an obligation taken on by a bank to make a payment once certain criteria
are met. Once these terms are completed and confirmed, the bank will transfer the funds. This
ensures the payment will be made as long as the services are performed.
A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a
line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations
under the contract. This can be used to essentially insure a buyer or seller from loss or damage due
to nonperformance by the other party in a contract.
For example a letter of credit could be used in the delivery of goods or the completion of a
service. The seller may request that the buyer obtain a letter of credit before the transaction occurs.
The buyer would purchase this letter of credit from a bank and forward it to the seller's bank. This
letter would substitute the bank's credit for that of its client, ensuring correct and timely payment.
A bank guarantee might be used when a buyer obtains goods from a seller then runs into
cash flow difficulties and can't pay the seller. The bank guarantee would pay an agreed-upon sum to
the seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the
purchaser the agreed-upon sum. Essentially, the bank guarantee acts as a safety measure for the
opposing party in the transaction.
These financial instruments are often used in trade financing when suppliers, or vendors,
are purchasing and selling goods to and from overseas customers with whom they don't have
established business relationships. The instruments are designed to reduce the risk taken by each
party.