Table of Contents

Financial Market refers to a system consisting of financial institutions (Banks, NBFCs), instruments (shares, bonds), organisation (stock exchange), and regulatory bodies (RBI, SEBI) which facilitate financial transactions.

Its objective is to make sure that capital flow and savings of household are mobilised for the benefit of the market.

Financial Market is categorised into:

  1. Money Market – Short term financial market of an economy.
  2. Capital Market – Long term financial market of an economy. 

Comparison: Money Market vs. Capital Market

Feature

Money Market

Capital Market

Duration

Short-term (up to 1 year).

Medium and Long-term (over 1 year).

Purpose

To meet working capital requirements.

To meet fixed capital requirements (assets).

Instruments

T-Bills, Commercial Paper, Call Money, Certificates of Deposit.

Shares, Debentures, Bonds, Retained Earnings.

Risk

Lower risk due to short duration and high liquidity.

Higher risk (market fluctuations and longer duration).

Liquidity

Highly liquid (easily converted to cash).

Comparatively less liquid.

Regulator

RBI (Reserve Bank of India).

SEBI (Securities and Exchange Board of India).

Participants

RBI, Commercial Banks, Financial Institutions.

Stock Exchanges, Brokers, Individual Investors, Insurance Companies.

Features of Money Market

The money market is essentially the "liquidity market" of the economy. Its features are as follows:

  1. Maturity of less than 1 year - These instruments are designed for immediate needs. Some, like "Call Money," can have a maturity of just 24 hours.
  2. Unsecured but Low Risk - Most money market instruments (like Commercial Paper) aren't backed by physical collateral. However, because they are issued by highly creditworthy institutions (the Government or top-tier banks/firms) for very short periods, the risk of default is extremely low.
  3. Highly Liquid - "Liquidity" refers to how fast an asset can be turned into cash without losing value. Since the durations are so short, these assets are considered "near-money."
  4. Meeting Temporary Shortages - Banks often face a "mismatch" where they need cash today but will receive payments tomorrow. The money market allows them to borrow for a few days to stay balanced.

Features of Capital Market

The capital market is the "wealth creation market," focusing on long-term industrial and national growth. Its features are as follows:

  1. Link between Savers and Investment: It channels the idle savings of households (who buy stocks/bonds) into productive use by corporations and the government.
  2. Long-term Investment: This market deals with permanent or semi-permanent capital. This money is used for "Capex" (Capital Expenditure) like building factories or highways.
  3. Uses Intermediaries: Because the duration is long and the risk is higher, you need brokers to execute trades, depositories (like NSDL or CDSL) to hold shares, and underwriters to guarantee the sale of new shares.
  4. Determinant of Capital Formation: "Capital Formation" means increasing the physical stock of real capital (machinery, equipment). By providing funds to businesses, the capital market directly increases the nation's productive capacity.
  5. Under Government Guidance: While prices are determined by supply and demand (market forces), regulators like SEBI ensure that rules are followed to protect investors from fraud.
  6. Facilitates Economic Growth: By ensuring that money flows to the most profitable and efficient businesses, the capital market helps the GDP grow over time.