UNIVERSITY OF LIVINGSTONIA

KANING’INA CAMPUS

FACULTY OF BUSINESS AND COMMUNICATION STUDIES

DEPARTMENT OF ACCOUNTANCY

NAME : SIMEON PENJANI CHUNGA

REG NUMBER : BAC/01/64/22

LECTURE’S NAME : MR MUSSI

YEAR : TWO

SEMESTER : FOUR

COURSE NAME : FINANCIAL MANAGEMENT

COURSE CODE : BAC 2401

TASK : ASSIGNMENT ONE

DATE DUE : 15 FEBRUARY 2024

Introduction

Money always flows from surplus sector to deficit sector. That means persons having excess of
money lend it to those who need money to fulfil their requirement. Similarly, in business sectors the
surplus money flows from the investors or lenders to the businessmen for the purpose of production
or sale of goods and services. So, we find two different groups, one who invest money or lend money
and the others, who borrow or use the money. The question that arises is how these two groups meet
and transact with each other. The financial markets act as a link between these two different groups.
It facilitates this function by acting as an intermediary between the borrowers and lenders of money.

Spencer, P. D. (2000) defined financial market as

a transmission mechanism between investors (or lenders) and the borrowers (or users) through which
transfer of funds is facilitated‟. It consists of individual investors, financial institutions and other
intermediaries who are linked by a formal trading rules and communication network for trading the
various financial assets and credit instruments.

Let us now see the main functions of financial market according to Dr. Babasaheb Ambedkar

Financial markets play a crucial role in fostering interaction between investors and borrowers.
Investors seek avenues to allocate their capital, while borrowers require funds for various purposes.
The financial market serves as a platform where these two parties can meet and engage in transactions,
allowing capital to flow from savers to those in need of funds for investment or other financial
endeavors.

One of the fundamental functions of financial markets is to provide pricing information. When buyers
and sellers participate in the market, they engage in the trading of financial assets, leading to the
establishment of market prices. This pricing mechanism reflects the collective information,
expectations, and sentiments of market participants, contributing to the efficient valuation of assets
(Pagano, M, 1993).

Security is a paramount aspect of financial markets, ensuring the integrity and reliability of
transactions involving financial assets. Regulatory frameworks, transparency measures, and
established protocols work together to instill confidence in market participants, fostering a secure
environment for the exchange of financial instruments.

Liquidity is a key characteristic that financial markets strive to maintain. By providing mechanisms
for investors to buy or sell financial assets easily, markets ensure that participants can enter or exit
positions with relative ease. This liquidity contributes to the smooth functioning of markets and
enhances the overall efficiency of capital allocation.

Moreover, financial markets aim to minimize the costs associated with transactions and information.
Efficiency in processing transactions and disseminating relevant information is vital for reducing
friction and enhancing accessibility. Low transaction costs make it more feasible for investors to
engage in market activities, contributing to the overall accessibility and inclusivity of the financial
system. Similarly, efficient information flow ensures that market participants can make well-informed
decisions, further enhancing the overall functioning of financial markets.

Capital market

Capital Market may be defined as a market for borrowing and lending long-term capital funds
required by business enterprises. Capital Market is the market for financial assets that have long or
indefinite maturity. Capital Market offers an ideal source of external finance.

Capital Market refers to all the facilities and the institutional arrangements for borrowing and
lending medium-term and long-term funds. Like any market, the Capital Market is also composed of
those who demand funds (borrowers) and those who supply funds (lenders) (Greenwood, J., & Smith,
B. D. 1997).

Transfer of resources from those with idle resources to others who have a productive need for them
is perhaps most efficiently achieved through the Capital Markets. Stated formally, Capital Markets
provide channels for reallocation of savings to investments and entrepreneurship and thereby
decouple these two activities. As a result, the savers and investors are not constrained by their
individual abilities, but by the economy’s abilities to invest and save respectively, which inevitably
enhances savings and investment in the economy. Savings are linked to investments by a variety of
intermediaries through a range of complex financial products called “securities”.

There are a set of economic units who demand securities in lieu of funds and others who supply
securities for funds. These demand for and supply of securities and funds determine, under
competitive market conditions in both goods and Securities Market, the prices of securities which
reflect the present value of future prospects of the issuer, adjusted for risks and also prices of funds.
It is not that the users and suppliers of funds meet each other and exchange funds for securities. It is
difficult to accomplish such double coincidence of wants. The amount of funds supplied by the
supplier may not be the amount needed by the user. Similarly, the risk, liquidity and maturity
characteristics of the securities issued by the issuer may not match preference of the supplier. In such
cases, they incur substantial search costs to find each other. Search costs are minimized by the
intermediaries who match and bring the suppliers and users of funds together. These intermediaries
may act as agents to match the needs of users and suppliers of funds for a commission, help suppliers
and users in creation and sale of securities for a fee or buy the securities issued by users and in turn,
sell their own securities to suppliers to book profit.

The Capital Market, thus, has essentially three categories of participants, namely; the issuers of
securities, investors in securities and the intermediaries. The issuers and investors are the consumers
of services rendered by the intermediaries while the investors are consumers (they subscribe for and
trade in securities) of securities issued by issuers. In pursuit of providing a product to meet the needs
of each investor and issuer, the intermediaries churn out more and more complicated products. They
educate and guide them in their dealings and bring them together. Those who receive funds in
exchange for securities and those who receive securities in exchange for funds often need the
reassurance that it is safe to do so. This reassurance is provided by the law and by custom, often
enforced by the regulator. The regulator develops fair market practices and regulates the conduct of
issuers of securities and the intermediaries so as to protect the interests of suppliers of funds. The
regulator ensures a high standard of service from intermediaries and supply of quality securities and
non-manipulated demand for them in the market. The market does not work in a vacuum; it requires
services of a large variety of intermediaries. The disintermediation in the Capital Market is in fact an
intermediation with a difference; it is a risk-less intermediation, where the ultimate risks are borne by
the savers and not the intermediaries.

In Malawi, the capital market consists of two interdependent and inseparable segments: the primary
market and the secondary market.

Firstly, Primary Market. This segment is where newly issued securities, such as stocks or bonds, are
first offered to the public. Companies or government entities use the primary market to raise capital
by issuing new securities. Investors acquire these securities directly from the issuer, and the proceeds
from the sales go to the issuing entity. In Malawi, the primary market plays a crucial role in facilitating
the initial funding needs of businesses and government projects.

The last segment is Secondary Market. The secondary market involves the trading of existing
securities among investors. Once securities are initially issued in the primary market, they can be
bought and sold on the secondary market. This market provides liquidity to investors who wish to
sell their securities, and it allows others to purchase these financial instruments. The secondary market
in Malawi contributes to price discovery, enhances liquidity, and enables investors to adjust their
portfolios based on changing market conditions.

These two segments of the capital market in Malawi work hand in hand, creating a dynamic
environment for the issuance and trading of securities. The primary market fuels the initial capital-
raising process, while the secondary market provides ongoing liquidity and a platform for investors
to trade existing securities. Together, they form a critical infrastructure for capital mobilization and
investment activities in the country.

Capital Market plays an important role in mobilizing resources, and diverting them towards
productive channels. In this way, it facilitates and promotes the process of economic growth in the
country as discussed below:

Firstly, link between Savers and Investors: The Capital Market functions as a link between savers and
investors. It plays an important role in mobilizing the savings and diverting them in productive
investment. In this way, Capital Market plays a vital role in transferring the financial resources from
surplus and wasteful areas to deficit and productive areas, thus increasing the productivity and
prosperity of the country (Darškuvienė, V. (2010).

Secondly, encouragement to Saving: With the development of Capital Market, the banking and non-
banking institutions provide facilities, which encourage people to save more. In the less- developed
countries, in the absence of a Capital Market, there are very little savings and those who save often
invest their savings in unproductive and wasteful directions, i.e., in real estate (like land, gold, and
jewellery) and conspicuous consumption.

Thirdly, Encouragement to Investment: The Capital Market facilitates lending to the businessmen
and the Government and thus encourages investment. It provides facilities through banks and
nonbank financial institutions. Various financial assets, e.g., shares, securities, bonds, etc., induce
savers to lend to the Government or invest in industry. With the development of financial institutions,
capital becomes more mobile, interest rate falls and investment increases (Valdez, S., & Molyneux,
P. 2017)

Another role is Promotion of Economic Growth: The Capital Market not only reflects the general
condition of the economy, but also smoothens and accelerates the process of economic growth.
Various institutions of the Capital Market, like non-bank financial intermediaries, allocate the
resources rationally in accordance with the development needs of the country. The proper allocation
of resources results in the expansion of trade and industry in both public and private sectors, thus
promoting balanced economic growth in the country (Valdez, S., & Molyneux, P. 2017)

Fifthly, Stability in Security Prices: The Capital Market tends to stabilize the values of stocks and
securities and reduce the fluctuations in the prices to the minimum. The process of stabilization is
facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative
and unproductive activities (Howells, P., & Bain, K, 2007).

Lastly, Benefits to Investors: The Capital Market helps the investors, i.e., those who have funds to
invest in long-term financial assets, in many ways: (a) It brings together the buyers and sellers of
securities and thus ensure the marketability of investments, (b) By advertising security prices, the
Stock Exchange enables the investors to keep track of their investments and channelize them into
most profitable lines, (c) It safeguards the interests of the investors by compensating them from the
Stock Exchange’s Investor Protection Fund in the event of fraud and default (Valdez, S., & Molyneux,
P. 2017).

According to (Pagano, M, 1993) Capital Market has a crucial significance to capital formation. For
a speedy economic development adequate capital formation is necessary. The significance of Capital
Market in economic development is explained below:

Firstly, Mobilization of Savings and Acceleration of Capital Formation. In Capital Market, various
types of securities help to mobilize savings from various sectors of population. The twin features of
reasonable return and liquidity in stock exchange are definite incentives to the people to invest in
securities. This accelerates the capital formation in the country.

Secondly, Raising Long-Term Capital. The existence of a stock exchange enables companies to raise
permanent capital. The investors cannot commit their funds for a permanent period but companies
require funds permanently. The stock exchange resolves this clash of interests by offering an
opportunity to investors to buy or sell their securities, while permanent capital with the company
remains unaffected (Bailey, R. E. 2005).

Thirdly, promotion of Industrial Growth. The stock exchange is a central market through which
resources are transferred to the industrial sector of the economy. The existence of such an institution
encourages people to invest in productive channels. Thus it stimulates industrial growth and economic
development of the country by mobilizing funds for investment in the corporate securities.
In addition to the roles is Readiness and Continuous Market. The stock exchange provides a central
convenient place where buyers and sellers can easily purchase and sell securities. Easy marketability
makes investment in securities more liquid as compared to other assets.

Another role is Technical Assistance. An important shortage faced by entrepreneurs in developing

countries is technical assistance. By offering advisory services relating to preparation of feasibility
reports, identifying growth potential and training entrepreneurs in project management, the financial
intermediaries in Capital Market play an important role.

Lastly, Provision of variety of services. The financial institutions functioning in the Capital Market
provide a variety of services such as grant of long term and medium term loans to entrepreneurs,
provision of underwriting facilities, assistance in promotion of companies, participation in equity
capital, giving expert advice etc.

Money Market

Money Market is a very important segment of a financial system. Monetary assets of short-term nature
up to one year and financial assets that are close substitutes for money are dealt in the Money Market.
Money Market instruments have the characteristics of liquidity (quick conversion into money),
minimum transaction cost and no loss in value. Excess funds are deployed in the Money Market,
which in turn is availed of to meet temporary shortages of cash and other obligations. Money Market
provides access to providers and users of short-term funds to fulfill their investments and borrowings
requirements respectively at an efficient market clearing price. It performs the crucial role of
providing an equilibrating mechanism to even out short-term liquidity, surpluses and deficits and in
the process, facilitates the conduct of monetary policy.

The Money Market is one of the primary mechanism through that influences liquidity and the general
level of interest rates in an economy. The influence on liquidity serve as a signaling-device for other
segments of the financial system. The Money Market functions as a wholesale debt market for low-
risk, highly liquid, short-term instruments. Funds are available in this market for periods ranging
from a single day up to a year. Mostly Government, banks and financial institutions dominate this
market. Bailey, R. E. (2005).

It is a formal financial market that deals with short-term fund management. Though there are a few
types of players in Money Market, the role and the level of participation by each type of player differs
largely. Government is an active player in the Money Market and in most of the economies; it
constitutes the biggest borrower in this market. For example, in India; both, Government securities
(G-secs) and Treasury bill (T-bill) is a security issued by RBI on behalf of the Government of India
to meet the latter’s borrowing for financing fiscal deficit. Apart from functioning as a banker to the
government, the central bank (RBI) also regulates the Money Market and issues guidelines to govern
the Money Market operations (Howells, P., & Bain, K. (2007). .

Another dominant player in the Money Market is the banking industry. Banks mobilize deposits of
savers in lending to investors of the economy. This process is known as credit creation. However,
banks are not allowed to lend out the entire amount for extending credit for investment. In order to
promote certain prudential norms for healthy banking practices, most of the developed economies
require all commercial banks to maintain minimum liquid and cash reserves in form of Statutory
Liquid Ratio (SLR) and Cash Reserve Ratio (CRR) framed under the policies of central banks. The
banks are required to ensure that these reserve requirements are met before directing deposits on their
credit plans. If banks fall short of these statutory reserve requirements, the deficit amount can be
raised using the Money Market.

Other institutional players like financial institutions, corporates, mutual funds (MFs), Foreign
Institutional Investors (FIIs) etc. also transact in Money Market to fulfill their respective short term
finance deficits and short falls. However, the degree of participation of these players depends largely
on the regulations formulated by the regulating authorities in an economy. For instance, the level of
participation of the FIIs in the Indian Money Market is restricted to investment in Government
securities only.

The below are Features of money market according to Valdez, S., & Molyneux, P (2017).

The Money Market is a wholesale market where the volumes of transactions are very large and is
settled on a daily basis. Trading in the Money Market is conducted over the telephone, followed by
written confirmation through e-mails, texts from the borrowers and lenders. There are a large number
of participants in the Money Market for example in money market of Malawi are; commercial banks,
mutual funds, investment institutions, financial institutions and finally the Reserve bank of Malawi.
The bank's operations ensure that the liquidity and short-term interest rates are maintained at levels
consistent with the objective of maintaining price and exchange rate stability. The Central Bank
occupies a strategic position in the Money Market. The Money Market can obtain funds from the
central bank either by borrowing or through sale of securities. The bank influences liquidity and
interest rates by open market operations, Re-purchase agreement (REPO) transactions changes in
Bank Rate, Cash Reserve Requirements and by regulating access to its accommodation. A well-
developed Money Market contributes to an effective implementation of the monetary policy as it
provides:

1. A balancing mechanism for short-term surpluses and deficiencies.

2. A focal point of central bank intervention for influencing liquidity in the economy, and

3.A reasonable access to the users of short-term funds to meet their requirements at
realistic/reasonable price or cost.

A well-developed money market is essential for a modern economy. Though, historically, money
market has developed as a result of industrial and commercial progress, it also has important role to
play in the process of industrialization and economic development of a country. Importance of a
developed money market and its various functions as discussed by Howells, P., & Bain, K. (2007):

Firstly, Financing Trade: Money Market plays crucial role in financing both internal as well as
international trade. Commercial finance is made available to the traders through bills of exchange,
which are discounted by the bill market. The acceptance houses and discount markets help in
financing foreign trade.

Secondly, Financing Industry: Money market contributes to the growth of industries in two ways:

(a) Money market helps the industries in securing short-term loans to meet their working capital
requirements through the system of finance bills, commercial papers, etc.

(b) Industries generally need long-term loans, which are provided in the capital market. However,
capital market depends upon the nature of and the conditions in the money market. The short-term
interest rates of the money market influence the long-term interest rates of the capital market. Thus,
money market indirectly helps the industries through its link with and influence on long-term capital
market.

Thirdly, Profitable Investment: Money market enables the commercial banks to use their excess
reserves in profitable investment. The main objective of the commercial banks is to earn income from
its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the
money market, the excess reserves of the commercial banks are invested in near-money assets (e.g.
short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the
commercial banks earn profits without losing liquidity.
Fourthly, Self-Sufficiency of Commercial Bank: Developed money market helps the commercial
banks to become self-sufficient. In the situation of emergency, when the commercial banks have
scarcity of funds, they need not approach the central bank and borrow at a higher Money Market 20
Introduction to Financial Markets, Money Market and Capital Market interest rate. On the other hand,
they can meet their requirements by recalling their old short-run loans from the money market.

The last one is Helping the Central Bank: Though the central bank can function and influence the
banking system in the absence of a money market, the existence of a developed money market
smoothens the functioning and increases the efficiency of the central bank. Money market helps the
central bank in two ways:

(a) The short-run interest rates of the money market serves as an indicator of the monetary and
banking conditions in the country and, in this way, guide the central bank to adopt an appropriate
banking policy,

(b) The sensitive and integrated money market helps the central bank to secure quick and widespread
influence on the sub-markets, and thus achieve effective implementation of its policy.

MONEY MARKET Vs. CAPITAL MARKET

The Money Market and Capital Market exhibit distinctive operational features, each serving unique
financial functions. Diverging primarily in terms of maturity period, credit instruments, and
institutions involved, these markets play crucial roles in the broader financial landscape. The Money
Market specializes in short-term financial transactions, typically one year or less, focusing on lending
and borrowing for immediate liquidity needs. Conversely, the Capital Market handles long-term
finance, extending beyond one year, facilitating investment in durable assets such as land, machinery,
and infrastructure (Howells, P., & Bain, K. (2007).

Credit instruments further differentiate the two markets. The Money Market relies on instruments like
Call Money, Treasury Bills, Commercial Bills, Commercial Papers, and Bills of Exchange to meet
short-term credit requirements. In contrast, the Capital Market employs instruments such as Stocks,
Shares, Debentures, Bonds, and Corporate Deposits, catering to long-term investment needs (Pagano,
M, 1993).

Institutions are integral components of both markets. The Money Market involves central banks,
commercial banks, acceptance houses, non-banking financial institutions, and bill brokers. On the
other hand, the Capital Market is characterized by institutions like stock exchanges, commercial
banks, insurance companies, and mortgage banks. These institutions play pivotal roles in facilitating
transactions, providing regulatory oversight, and ensuring the smooth functioning of their respective
markets (Pagano, M,1993).

The purpose of loans further distinguishes these markets. The Money Market meets short-term credit
needs, supplying working capital to industrialists, while the Capital Market addresses long-term credit
requirements, providing fixed capital for substantial investments. Moreover, the Money Market tends
to have lower risk and higher liquidity, making it suitable for short-term financial activities, while the
Capital Market carries higher risk and lower liquidity due to its focus on long-term investments.

Pagano, M. (1993) emphasized that the role of central banks in these markets also varies. In the
Money Market, central banks directly impact participants by framing regulations and setting interest
rates that influence economic parameters. In contrast, the Capital Market sees an indirect link between
central banks and participants, with other regulators like the Securities and Exchange Board of India
(SEBI) playing a more prominent role.

According to Bailey, R. E. (2005) Market regulation is another distinguishing factor. Commercial

banks in the Money Market are closely regulated, ensuring the stability of short-term financial
activities. In contrast, institutions in the Capital Market face less stringent regulations, allowing for a
more flexible environment to facilitate long-term investments. Overall, the Money Market and
Capital Market, while interlinked in the broader financial system, serve distinct purposes and exhibit
varying characteristics to meet the diverse needs of investors and borrowers.

Analysis

The comparison between the capital market and the money market is a complex issue that involves
various factors such as risk, return, liquidity, and investment horizon. Both markets play crucial roles
in the overall financial system, but they serve different purposes and cater to different types of
investors. The capital market deals with long-term securities, such as stocks and bonds, while the
money market focuses on short-term debt instruments like Treasury bills and commercial paper. To
determine which is the best financial market between the two, it is essential to consider the specific
needs and objectives of the investor.

The capital market offers higher potential returns compared to the money market due to the longer
investment horizon associated with stocks and bonds. Additionally, investing in the capital market
provides an opportunity for capital appreciation through stock price appreciation and interest income
from bonds. However, it is important to note that the capital market also carries higher risk compared
to the money market. The volatility of stock prices and fluctuations in bond yields can lead to
significant fluctuations in investment value.

On the other hand, the money market offers greater liquidity and lower risk compared to the capital
market. Short-term debt instruments in the money market are highly liquid and typically have a fixed
value at maturity, making them less susceptible to market fluctuations. Furthermore, money market
investments are often considered as safe havens for preserving capital and maintaining short-term
liquidity needs. In terms of investment objectives, investors with a long-term horizon and a higher
risk tolerance may find the capital market more suitable for achieving their financial goals.
Conversely, investors with short-term liquidity needs and a lower risk tolerance may prefer the money
market for its stability and immediate access to funds.

Conclusion
In nutshell, there is no definitive answer as to which financial market is better between the capital
market and the money market. The choice between the two depends on individual investor
preferences, risk appetite, investment horizon, and financial objectives.
 References

Pagano, M. (1993). Financial markets and growth: An overview. European economic review, 37(2-
3), 613-622.

Bailey, R. E. (2005). The economics of financial markets. Cambridge University Press.

Greenwood, J., & Smith, B. D. (1997). Financial markets in development, and the development of
financial markets. Journal of Economic dynamics and control, 21(1), 145-181.

Darškuvienė, V. (2010). Financial markets. Vytautas Magnus University. Kaunas.

Howells, P., & Bain, K. (2007). Financial markets and institutions. Pearson Education.

Pilbeam, K. (2018). Finance and financial markets. Bloomsbury Publishing.

Valdez, S., & Molyneux, P. (2017). An introduction to global financial markets. Bloomsbury
Publishing.

Spencer, P. D. (2000). The structure and regulation of financial markets. OUP Oxford.