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Money markets and financial markets are both types of financial markets. Financial instrument in economics is addressed as a system that facilitates the trading of financial securities and goods at low costs. On the other hand a market can be defined as a place where buyers and sellers interact and make it possible to transact goods and services. The securities and commodities traded include stocks, bond, agricultural goods and any other valuable good. Prices in these markets reflect effective market theory. Financial markets are crucial factors in an economy because without the financial markets it will be hard for both the borrowers and the lenders to find each other. Banks are an example of an intermediary which collects money from the depositors and provide loans and mortgages to those who are willing to borrow. The stock exchange enables companies to sell their shares to the public. (Sherris)
Money markets facilitate transfer of liquidity with assets that require a maturity of one year or less. Transactions that occur in the money markets involves bankers acceptance, federal funds, treasury bills, short term mortgages, commercial papers and securities that are backed by an asset. It offers liquidity support for the financial system globally. Money markets have financial institutions which are willing to offer or receive credit. These money transactions are meant for short term periods of not more than one year. Commercial papers are the short term instruments that are used in money markets. Those who participate in these markets are banks which lend and borrow money from each other using commercial papers or similar instruments which may be found reliable. To determine the suitable term and currency bench marking is always done to these instruments using the London Interbank Offered Rate. Finance companies mostly fund there businesses using asset backed commercial papers which have collateral of qualified assets.
Qualified assets include credit cards receivables, mortgage-backed securities, auto loans, residential mortgage loans and any other financial asset that is fully owned to the company. Also certain big corporations with well-built credit ranking fund themselves using their commercial papers to get credits. Corporations can also organise with the banks to issue commercial papers in their names through the commercial paper line. In the United States, issue of municipal papers for funding is done by state, federal and local government. The United States public debt is always funded by the treasury through the issue of treasury bills. Apart from commercial banks central and merchant banks, institutional and retail money markets funds, cash management program, Arbitrage conduits and trading companies also participate differently in the money markets.
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Trading companies for example buy bankers’ acceptance that should be paid by suppliers from abroad while Arbitrage conduits buy those papers with high yield as they sell cheaper papers. The instruments that are commonly used in money markets are the following commercial papers which refer to a promissory note that is not secured always sold at a discount with its maturity ranging from one to two hundred and seventy days. The other one is the repurchase agreement which always sold to an investor and repurchased on a fixed price and date as agreed. Others are certificate of deposit, Eurodollar deposit, municipal notes, federal funds, money funds, treasury bills and foreign exchange swaps.
Capital markets are majorly used to raise capital. Capital markets facilitate markets for debts and equities where companies and governments access long-term funds. Money in these markets is traded for periods of more than one year. Capital markets comprises of the stock markets which trade in equities and bond markets which trade in debts. Examples of financial controllers are the Financial Services Authority in the United Kingdom and Securities and Exchange Commission in the United States that ensure capital markets within their jurisdiction do not exploit investors through fraud or and other financial deception. Capital markets are classified as either primary markets or secondary markets. Primary markets allow the trading of new bonds and stocks by underwriting. The secondary market on the other hand facilitates the trading of securities that already exist in the market through security exchange or over the counter.
The difference between the money markets tools and the capital markets tools can now be explained easily from the above information. The difference between the two tools is described based on the maturity period of the instruments used and claim. Money markets deal with short term instruments which mature within a period of one year or less while capital markets trade with financial assets and claims that have a long maturity period of more than one year. Both markets are involved in the transfer of finances though the difference is evident in the duration taken by the transaction involved. Money markets deal with short term financial instruments like commercial papers, certificate of deposit, inter-corporate deposits, treasury bonds and commercial bills. On the other hand capital markets facilitate trading in securities such as government debt instrument and common finance units.
The objective of the capital markets is to provide a financial instrument with a long term maturity while the aim of the money markets is on the short term instruments. The participants in the money markets are always large financial institutions which include corporate bodies, commercial and central banks, acceptance houses, nonbank financial institutions, bill brokers and common funds. Capital markets on the other hand allow any person to participate in trading debentures, common fund units and shares. There are no restrictions in the capital markets regarding the amount of money held it involves both large and small investors. Institutions involved in capital markets are nonbank institutions such as building societies and insurance companies, stock exchanges and commercial banks. (Sherris)
Capital market is divided into primary market and secondary market. These two markets are related and depend on each other. This is because in primary markets new securities are traded for the first time after which they will never be traded again in the primary markets instead they will be traded in the capital markets. This is how the secondary market results from the primary market. On the other hand there is no segmentation of markets in the money markets. An effective money market facilitates secondary market transactions. Also the money markets have fur much more transactions than the capital markets. This is because the instruments traded in money markets require less procedures and time to mature or to be completed. For example depositing or borrowing from a bank takes less time and is done by very many people in a day.
On the other hand transaction on the capital markets requires long procedures and time. For example for someone to buy or sell shares in a stock exchange various factors must be considered. One of these factors is the relative price of the share compared to the prices of similar shares. Money markets has various financial instruments which are used to transact short term transactions and they include commercial papers, certificate of deposits, treasury bills, call money and other instruments mentioned earlier. On the other hand capital markets use the following instruments in conducting long term transactions equity shares, preference shares, public bonds, common funds and various types of debentures which can either be secured or unsecured. (Sherris)
Investments in capital markets have more speculations than those investments done in money markets. This is because instruments used in capital markets have a long term maturity compared to the short term maturity in the primary markets. The long term period reduces certainty hence more speculations in capital markets. In business investments that involve high risk and long life span always have more returns than those which have less risk and short life span. This makes capital markets to have more returns than primary markets. The other difference between the money and the secondary markets tools is caused by the nature of credit instruments used to conduct transactions in the two markets. The financial instruments used to facilitate credit in capital markets are more diverse than those used in primary markets. It is important for credit instruments in financial markets to have a number of homogeneity. Excess diversity may cause complexity which may create problems to potential investors.
Those investors who need short term finances will always be found in primary markets while those investors who intend to acquire long term funds are found in capital markets. There is also difference in the use of funds derived from these two markets. The funds acquired from the primary markets are used short credit demand and provide working capital for firms. On the other hand funds acquired from the capital markets are used for long term credit demands and facilitate fixed capital for purchases of machinery, land and other fixed assets. The basic roles played by the two markets is also different in that money markets facilitates transfer of liquidity while capital markets puts capital to a long term work, industrious and secure employment. The relation of the two markets with the central bank of a given country is also different. Primary markets are directly related to the central bank unlike the capital markets which feel the effect through the primary markets. (Machiraju).
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