MONEY MARKET vs.

CAPITAL MARKET
What is Money Markets?

• markets that trade debt securities with maturities of one year or less (e.g. CD’s, U.S.
Treasury bills)

• An unorganized arena of banks, financial institutions, bill brokers, money dealers, etc.
wherein trading on short-term financial instruments is being concluded is known as
Money Market. These markets are also known by the name wholesale market.

Securities Traded in Money Markets

1.Treasury Bills.

2 Certificate of Deposit (CDs).

3 Commercial Papers.

4 Eurodollar Deposits.

5 Federal Funds.

6 Banker’s Acceptance.

7 Repurchase Agreements

Treasury Bills

• A Treasury Bill (T-Bill) is a short-term debt obligation backed by the Treasury Department of the
U.S. government with a maturity of less than one year, sold in denominations of $1,000 up to a
maximum purchase of $5 million on noncompetitive bids. T-bills have various maturities and are
issued at a discount from par.

Certificate of Deposits(CDs)

• is a financial asset issued by a bank or thrift that indicates a specified sum of money
deposited at the issuing depository institution.

• Banks & Thrift issue CDs to raise funds for financing their business activities

Commercial Paper(CP)

• Is a short-term unsecured promissory note issued in the open market that represents the
obligation of the issuing corporation.

• The issuance of commercial paper is an alternative to bank borrowing for large

corporations (non-financial & financial) with strong credit ratings

• The original purpose of CP was to provide short-term funds for seasonal and working
capital needs, but companies use this instrument for other purposes. It is used quite often
to bridge financing.

• Securities Act of 1933 in the US, requires the Commercial Paper be registered with SEC
if maturity date exceeds 270 days
Credit-Supported Commercial Paper

• It is where Small and less well-known companies with lower credit rating could get credit
support from a firm with a high credit ratings

❖ An example of Credit-Supported CP is one supported by a Letter of Credit. The terms of

the letter of credit specify that the bank issuing the letter guarantees that the bank will pay
off the paper when it comes due. If the issuer fails to do so. The bank will charge a fee for
the letter of credit.

❖ From the issuer’s perspective, the fee enables it to enter the commercial paper market and
thereby obtain funding at a lower cost than that of bank borrowing.

Asset-Backed Commercial Paper

• Collateralizes the issue of commercial paper with high quality assets

Organizations that evaluate the credit risk of entities issuing debt obligations and assign a
letter of rating based on the likelihood of default:

1. Moody’s Investors Service

2. Standard & Poor’s

3. Fitch

The term Eurodollar

• refers to U.S. dollar-denominated deposits at foreign banks or at the overseas branches of

American banks.

• By being located outside the United States, eurodollars escape regulation by the Federal
Reserve Board, including reserve requirements. Dollar-denominated deposits not subject to U.S.
banking regulations were originally held almost exclusively in Europe, hence the name
eurodollar. They are also widely held in branches located in the Bahamas and the Cayman
Islands

• Eurodollar is a term that refers to any United States dollar (“U.S. dollar”) held outside the U.S.
banking system

What are Federal Funds

• Federal funds, often referred to as fed funds, are excess reserves that commercial banks and other
financial institutions deposit at regional Federal Reserve banks; these funds can be lent, then, to
other market participants with insufficient cash on hand to meet their lending and reserve needs

Bankers Acceptance(BA)

• Is a vehicle created to facilitate commercial trade transactions.

• It is where a bank accepts the ultimate responsibility to repay a loan to its holder

• The use of bankers acceptances to finance a commercial transactions is referred to as

Acceptance Financing
Transactions in which Bankers Acceptances are created include:

1. The importers of goods into the US

2. The exporting of goods from the US to Foreign Entities

3. The storing and shipping of goods between two Foreign Entities

4. The storing and shipping of goods between two Entities in the US.

Note:

1. BA are sold on a discounted basis just as Treasury Bills and Commercial Paper

2. To calculate the rate to be charged the customer for issuing a Bankers Acceptance, a bank
determines the rate for which it can sell its BA in the open market.

Repurchase Agreement

• Is the sale of a security with a commitment by the seller to buy the security back from the
purchaser at a specified price at a designated future date.

• It is basically a collateralized loan where a collateral is a security

• The collateral in a repo can be money market instruments, treasury securities, federal agency
securities, mortgage-backed securities or asset-backed securities.

Note: Despite the high quality collateral typically underlying a repo transaction, both parties to the
transactions are exposed to ‘CREDIT RISK”

What is Capital Markets?

• markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one
year

• A type of financial market where the government or company securities are created and traded
for the purpose of raising long-term finance to meet the capital requirement is known as Capital
Market

• includes both dealer market and auction market. It is broadly divided into two major categories:
Primary Market and Secondary Market

Primary Market:

• A market where fresh securities are offered to the public for subscription is known as Primary
Market.

• markets in which users of funds (e.g. corporations, governments) raise funds by issuing financial
instruments (e.g. stocks and bonds)

Secondary Market:

• A market where already issued securities are traded among investors is known as Secondary Market.
• markets where financial instruments are traded among investors (e.g. NYSE, NASDAQ)
Securities Traded in Capital Markets

Debt Securities:

• Treasury Notes and Bonds.

• Municipal Bonds.

• Corporate Bonds.

• Mortgages.

Equity Securities:

• Commons Stocks.

• Preferred Stocks.

Derivative Instruments:

• Futures contract
• Forward contract
• Option
• Swap

MONEY MARKET versus CAPITAL MARKET

Basis for
Money Market Capital Market
Comparison
A segment of the financial market where lending A section of financial market where long term
Meaning
and borrowing of short term securities are done. securities are issued and traded.
Nature of Market Informal Formal

Financial Treasury Bills, Commercial Papers, Certificate of Shares, Debentures, Bonds, Retained
instruments Deposit, Trade Credit etc. Earnings, Asset Securitization, Euro Issues
etc.
Central bank, Commercial bank, non-financial Commercial banks, Stock exchange, non-
Institutions institutions, bill brokers, acceptance houses, and banking institutions like insurance companies
so on. etc.
Risk Factor Low Comparatively High
Liquidity High Low
To fulfill long term credit needs of the
Purpose To fulfill short term credit needs of the business.
business.
Time Horizon Within a year More than a year
Merit Increases liquidity of funds in the economy. Mobilization of Savings in the economy.
Return on
Less Comparatively High
Investment