Question

Explain the difference between the terms in each of these pairs. a. savings investment b. capital market money market c. primary market secondary market

Short answer

Savings is setting aside income; investment involves risk and potential return. Capital markets handle long-term securities; money markets deal with short-term. Primary markets issue new securities; secondary markets trade existing ones.

Step-by-step solution

Understand Savings vs. Investment

Savings refers to the portion of income that is not consumed and is set aside for future use. It is often deposited in banks or saved in accounts that earn low interest. Investment, on the other hand, involves using money to purchase assets or financial instruments that are expected to generate a return over time, typically with a higher level of risk compared to savings.

Differentiate Capital Market from Money Market

The capital market is a financial market that deals with long-term securities, like stocks and bonds, which have maturities longer than one year. It facilitates raising capital for long-term projects. In contrast, the money market is a segment of the financial market dealing with short-term borrowing and lending, typically for instruments like treasury bills and commercial papers with maturities of less than one year.

Compare Primary Market with Secondary Market

The primary market is where new securities are created and sold for the first time, such as during an Initial Public Offering (IPO). This market enables issuers, like companies or governments, to raise fresh capital directly from investors. The secondary market is where existing securities are bought and sold among investors after the original issuance, providing liquidity and pricing information.

Key concepts

Savings vs. Investment

When it comes to financial markets, it's crucial to understand the distinction between savings and investment. Savings is essentially the portion of your income that you choose not to spend on immediate needs and rather set aside for future use. Generally, savings are stored in safe, low-risk accounts at financial institutions like banks. These accounts might include savings accounts or certificates of deposit, which usually offer low interest rates but a high level of safety.

• Low risk due to fewer chances of losing your principal amount.
• Emphasis on maintaining liquidity and ensuring funds are available when needed.

On the other side, investment involves allocating money with the hope of generating income or profit over time by purchasing assets such as stocks, bonds, or mutual funds. Unlike savings, investment carries a higher level of risk but also offers the potential for greater returns.

• The potential for higher returns than typical savings accounts.
• Involves risk, which means the value of investments can fluctuate.
• Typically focuses on long-term growth rather than immediate liquidity.

Capital Market vs. Money Market

Financial markets can broadly be classified into capital markets and money markets, each serving different purposes within an economy. The capital market is where long-term securities, such as stocks and bonds, are issued and traded. This market is essential for raising funds for long-term projects and investments. It includes exchanges where corporations and governments can secure financing through the issuance of securities.

• Handles instruments with maturities longer than one year.
• Includes both primary and secondary markets for trading long-term instruments.

In contrast, the money market is designed for short-term borrowing and lending, dealing with financial instruments that generally have maturities of less than one year. This segment includes treasury bills, commercial papers, and certificates of deposit. Money markets help organizations manage their short-term funding needs and contribute to the overall liquidity in the financial system.

• Cater to short-term liquidity needs.
• Typically involves lower risk and yield compared to capital markets.

Primary Market vs. Secondary Market

In understanding how securities are bought and sold, it's vital to differentiate between the primary and secondary markets. The primary market is where securities are created and sold for the first time. For example, during an Initial Public Offering (IPO), companies sell new stocks directly to investors to raise capital. Here, funds go directly from investors to the companies or issuers, and this process often involves underwriters.

• Facilitates the initial sale of new securities.
• Enables companies to raise fresh capital directly from investors.

The secondary market, however, is where existing securities are traded among investors after their initial issuance. It is commonly referred to as the “stock market,” and its main function is to provide liquidity and establish market prices for securities. This is the arena in which buyers and sellers interact, and the exchange of securities doesn't result in capital being directly transferred to the issuing companies.

• Provides a platform for trading existing securities between investors.
• Offers liquidity for investors to easily buy or sell securities.