Basics of the Financial Markets – Money and Capital Market

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In this article you will get the basics of financial markets that will help you in understanding the money and capital market.

The financial market is an institutional arrangement in which people trade financial securities, commodities.  It facilitates the trading of financial securities at low transaction costs. The values of the financial securities reflect the prices that in turn reflect the demand and supply condition of the market. It is a place where companies reduce risks by diversification and investors make money. It facilitates the allocation and creation of credit. There are mainly two different types of financial market namely money market and capital market. These markets are categorised on the basis of the maturity period of the credit provided.

Basics of financial markets: Money Market

Money market deals in short term funds that provide short term debt and facilitate financing and investment using a different type of instruments. These instruments include bills of exchange, promissory notes, Treasury bills etc. It simply refers to a collective name given to all institutions like commercial banks, indigenous banks which are dealing in short term funds.

Some basic features of the money market

  • It facilitates the trading of short term (up to one year) financial securities. These securities are considered as close substitutes to the cash in hand. Its maturity extends to one year or less and it deals with working capital.
  • The financial instruments are highly liquid with little chance of loss.
  •  The money market is dichotomised.
  • Money market instruments are safer than the other instruments of the financial market. This is because of their high liquidity and short maturities.

Major roles played by the money market

  • It provides an impetus to the development of various financial institutions like commercial banks and others by allowing them to use their excess reserves in profitable investment and also to maintain their liquidity. it makes these institutions self-sufficient in a case of emergency. When the commercial banks have a scarcity of funds they need not approach the central bank at the higher interest rate. They can meet their requirement by recalling their short-run loans from the money market. Hence money market strengthens the banking system.
  • The money market allows the government in borrowing short term funds at a low-interest rate. It further helps to use this money for development works of the country. It also reduces the unnecessary pressure on government like inflationary pressure or increasing debt.
  • Money market promotes liquidity, safety, financial mobility and also economise the use of cash.

Some limitations of the money market

  • The money market is dichotomous but there is an absence of coordination between the organised and unorganised money market. The organised sector consists of modern and scientific operating financial institution. Whereas the unorganised sector is widely scattered lack scientific organization, orthodox in approach and is stagnant and ill organised. The difference between the interest rates of both sectors is quite large that creates confusion among investors and depositors.
  • There is a lack of fund in the Indian money market. Its main reason is an unorganised working pattern, lower income, lower saving and lack of banking habits among people is also responsible for it.
  • There is a shortage of investment instruments in the money market of India. It leads to a lack of liquidity, elasticity, investment and profitability in the economy.

Basics of financial markets: Capital Market

Capital market deals in long term and medium-term loans using government securities, bonds, mortgages, and other instruments of long term debts. The capital market facilitates investment activities in fixed and working capital by the industries and common investors and borrowing funds for more than one year. It functions through Stock Exchange. The capital market consists of the stock market and bond market. We can further categorise the capital market in the primary market and the secondary market. Primary market deals with financial securities introduced first time in the market, while the secondary market deals with existing financial securities in the market and generally traded by the common investors and traders.

Some basic features of the capital market

  • It facilitates the trading of medium and long term securities with maturity over one year. It works with fixed and working capital.
  • Capital market deals with marketable as well as non-marketable securities.
  • It is highly regulated as it operates freely but under the framework of government rules and regulations.
  • It acts as an ideal channel between those who save and those who invest.
  • The capital market determines capital formation.

Role of the capital market

  • Capital market plays an important role in the mobilisation of the savings in the economy. It provides long term funds for investment in the productive channels of an economy. capital market diverts ideal resources like gold, jewellery, conspicuous consumption to productive channels and increases economic activities.
  • It allows continuous availability of funds and hence promotes more savings as well as investment and then speed the economic growth.
  • Capital market plays an important role in improving the policy framework of a country. When the policies are unfavourable the equity and bond prices tend to fall. Hence capital markets anticipate the future prospects of a country that provide long term gains and reduce the chances of loss.

Some limitations of the capital market

  • Capital market is considered as the creation of policy in the underdeveloped economies rather than due to the growth of industries and production level as in the advanced country. There is the confusion of ownership and management of capital market between the private and public authorities which reduces its efficiency.
  • Poor fiscal policy management, elementary money and restricted demand because of poor equity supply, all conspire to curtail market development. There is also a low level of public trust due to political instability and continuous evasion of purchasing power. these problems are the results of excessive public expenditure deficits in developing countries. There is also a lack of competitiveness in the financial market.
Juhi Singh
M.A. Economics

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