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Differences between Money Markets and Capital Markets. Major Points Money Markets Capital Markets Participant Institutional participants like RBI, Financial institutions, banks, corporate banks, financial institutions and entities, foreign investors and ordinary finance companies. Individual retail investors from the members of the investors are permitted to transact but public. do not normally do so Instruments Short term debt instruments such as Equity shares, debentures, bonds and T-bills, trade bills reports, commercial preference shares etc. paper and certificate of deposit. Investment Transactions require huge sums of Do not require a huge financial outlay. Outlay money and are quite expensive The value of units of securities is generally low i.e. Rs. 10, 100 and minimum trading lot of shares is kept small as 50 or 100 units. Duration Instruments usually have a maximum Deals in medium and long term tenure of one year and may even be securities such as equity share and issued for a single day. debentures Higher liquidity since the DFHI the Considered as liquid instruments Liquidity Discount Finance House of India has because they are marketable on the been established for the specific stock exchanges, However it might be objective of providing a ready market difficult to find a buyer sometimes with for these instruments. the fluctuations of the stock market. Minimum risk and are safer since the Riskier because of the long duration and Safety issuers mostly are the agencies of the may be the issuing companies fail to Government and also because of the perform as per the projection shown shorter duration. during issue. Expected Less High for long duration earnings are return through dividend and bonus shares. Mutual Funds: In everyday terms, a mutual fund is a pool of money collected for investment in the stock market or money markets for optimum returns. According to the Investor Words definition, a mutual fund is an open-ended fund operated by an investment company, which raises money from shareholders and invests in a group of assets, in accordance with a stated set of objectives. For most mutual funds, shareholders are free to sell their shares at any time, although the price of a share in a mutual fund will fluctuate daily, depending upon the performance of the securities held by the fund. Just as Banks have the Reserve Bank of India, the Securities and Exchange Board of India (SEBI) is the regulatory authority for Mutual Funds. In their offer document, mutual funds announce the manner in which the money would be invested, whether in stocks or elsewhere, in what proportion, and also provide a risk assessment of the scheme for the investor's information. But one must be aware that higher returns are always accompanied by high risks. Besides, mutual fund investments are subject to market risks, so do read the offer document carefully before you invest. You have the option to invest when a new fund is launched or you can invest in an on-going scheme, which has a satisfactory performance record. A one-time compliance of the Know Your Customer (KYC) norm is essential before you can invest in mutual funds. Exercise due diligence before investing. Repose trust in the fund. And set a reasonable time for the fruits to ripen before you pluck PROS -Your investment is in the hands of an expert. The fund manager is ably supported by a team of analysts and researchers and therefore, you can hope for an efficient and judicious handling of your money. Over a decent stretch of time, wealth creation is possible, when the returns are greater than the tax and inflation rates. -Investment can be in small or big amounts, in regular SIPs (Systematic Investment Plan) or at random intervals, entirely at your convenience. -You will be able to create a diverse portfolio so that all the eggs are not in one basket. A downtrend in one segment of the economy will be offset by another. This is important when you have no clue about the various companies listed in the exchanges. -The Net Asset Value (NAV) of your investment is available online. This enables the ease of tracking your investment at your convenience. Redemption or encashment is easy. The end-of- day value as declared by the fund, multiplied by the number of units held by you will be credited to the bank account provided by you. -Tax benefits accrue. Investments in specified schemes are tax deductible. Dividend income is tax exempt and the redemption after three years does not attract capital gains tax. CONS -When you invest, there is an entry load or charge. This means that if you invest Rs. 5,000, after deduction maybe Rs.4,900 or so is actually invested. Straightaway, there is a sense of loss. In certain cases, at the time of redemption, there may be an exit load too. -Mutual funds are best in the long term, more than five years or even closer to 10. They are also subject to market risks. In the event of a fall in the market, the principal you had put in can be fast eroded and rebuilding the corpus can be quite a painful experience. -As an amateur and believing in the long term, you may unknowingly continue to put in money in a losing venture. There may be occasions when the erosion and uncertainty can cause unnecessary panic. -Though in the hands of experts, not all funds have been able to generate excellent returns consistently. And as past performance is not a measure of the future, for your own sake, you need to stay invested and be alert and aware of economic developments. -There is no assurance or guarantee of return, either of the principal or of dividend. Future projections are at best theoretical. A healthy risk appetite is recommended. What is Net Asset Value (NAV) of a scheme? The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme. What are the different types of mutual fund schemes? Schemes according to Maturity Period: A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period. Open-ended Fund/ Scheme An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity. Close-ended Fund/ Scheme A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis. SPOT MARKET What It Is: Also called the cash market or the physical market, the spot market is where assets are sold for cash and delivered immediately. How It Works/Example: Spot markets differ from futures markets in that delivery takes place immediately. For example, if you wish to purchase Company XYZ shares and own them immediately, you would go to the cash market on which the shares are traded (the New York Stock Exchange, for example). If you wanted to buy gold on the spot market, you could go to a coin dealer and exchange cash for gold. The foreign exchange (FOREX) market is one of the largest spot markets in the world. People and companies all over the world are constantly exchanging one currency for another as transactions occur all over the globe. Why It Matters: It is important to know the difference between the spot market and the futures market as well as the difference between spot prices and futures prices. This difference -- known as the time spread -- is important economically because it illuminates the market's expectations about futures prices. For the most part, spot markets are influenced solely by supply and demand, whereas futures markets are also influenced by expectations about future prices, storage costs, weather predictions (for perishable commodities in particular), and a host of other factors. FUTURES MARKET What It Is: Futures are financial contracts giving the buyer an obligation to purchase an asset (and the seller an obligation to sell an asset) at a set price at a future point in time. How It Works/Example: Futures are also called futures contracts. The assets often traded in futures contracts include commodities, stocks, and bonds. Grain, precious metals, electricity, oil, meat, orange juice, and natural gas are traditional examples of commodities, but foreign currencies, emissions credits, bandwidth, and certain financial instruments are also part of today's commodity markets. There are two kinds of futures traders: hedgers and speculators. Hedgers do not usually seek a profit by trading commodities but rather seek to stabilize the revenues or costs of their business operations. Their gains or losses are usually offset to some degree by a corresponding loss or gain in the market for the underlying physical commodity. Speculators are usually not interested in taking possession of the underlying assets. They essentially place bets on the future prices of certain commodities. Thus, if you disagree with the consensus that wheat prices are going to fall, you might buy a futures contract. If your prediction is right and wheat prices increase, you could make money by selling the futures contract (which is now worth a lot more) before it expires (this prevents you from having to take delivery of the wheat as well). Speculators are often blamed for big price swings, but they also provide liquidity to the futures market. Futures contracts are standardized, meaning that they specify the underlying commodity's quality, quantity, and delivery so that the prices mean the same thing to everyone in the market. For example, each kind of crude oil (light sweet crude, for example) must meet the same quality specifications so that light sweet crude from one producer is no different from another and the buyer of light sweet crude futures knows exactly what he's getting. Futures exchanges depend on clearing members to manage the payments between buyer and seller. They are usually large banks and financial services companies. Clearing members guarantee each trade and thus require traders to make good-faith deposits (called margins) in order to ensure that the trader has sufficient funds to handle potential losses and will not default on the trade. The risk borne by clearing members lends further support to the strict quality, quantity, and delivery specifications of futures contracts. Regulation The Commodity Futures Trading Commission (CFTC) regulates commodities futures trading through its enforcement of the Commodity Exchange Act of 1974 and the Commodity Futures Modernization Act of 2000. The CFTC works to ensure the competitiveness, efficiency, and integrity of the commodities futures markets and protects against manipulation, abusive trading, and fraud. Futures Exchanges There are several futures exchanges. Common ones include The New York Mercantile Exchange, the Chicago Board of Trade, the Chicago Mercantile Exchange, the Chicago Board of Options Exchange, the Chicago Climate Futures Exchange, the Kansas City Board of Trade, and the Minneapolis Grain Exchange. Why It Matters: Futures are a great way for companies involved in the commodities industries to stabilize their prices and thus their operations and financial performance. Futures give them the ability to "set" prices or costs well in advance, which in turn allows them to plan better, smooth out cash flows, and communicate with shareholders more confidently. Futures’ trading is a zero-sum game; that is, if somebody makes a million dollars, somebody else loses a million dollars. Because futures contracts can be purchased on margin, meaning that the investor can buy a contract with a partial loan from his or her broker, futures traders have an incredible amount of leverage with which to trade thousands or millions of dollars worth of contracts with very little of their own money. For additional reading: http://web.mit.edu/rpindyck/www/Papers/Dynamics_Comm_Spot.pdf
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