Financial Institutions – SS2 Economics Lesson Note (Third Term)

The money market is where short-term securities are traded, while the capital market is where long-term securities are traded. Participants in the money market lend and borrow on a short-term basis, using instruments such as treasury bills and bills of exchange. The capital market supplies long-term funds to entrepreneurs, government and business firms through shares, stocks, bonds and debentures.

Behavioural objectives

By the end of the lesson, students should be able to:

• define the money market and the capital market;
• list the instruments and institutions of each market;
• distinguish between a treasury bill and a treasury certificate;
• explain the terms share, stock, development stock, bond and debenture;
• state the functions of the money market and the capital market.

What is the money market?

A money market is a market where short-term securities are traded. The market comprises institutions or individuals who either have money to lend or wish to borrow on a short-term basis.

Instruments used in the money market

1. Treasury bills
2. Treasury certificates
3. Bill of exchange
4. Call money funds

• Treasury bill: This is issued by the Central Bank. It enables the government to raise capital for ninety days.
• Treasury certificate: It is also a means by which the government raises short-term loans. Unlike a treasury bill, however, a treasury certificate falls due for repayment in twelve to twenty-four months. Because of its longer maturity, it earns a higher rate of discount than the treasury bill.
• Bill of exchange: This is a promissory note where the debtor acknowledges the debt and intends to pay within ninety days.
• Call money funds: Participating institutions invest surplus money through a special arrangement on an overnight basis, with interest, and can withdraw it on demand to meet their immediate requirements. This enhances the liquidity of the money market.

Institutions involved in the money market

1. Central Bank
2. Commercial banks
3. Acceptance houses
4. Finance houses
5. Discount houses
6. Insurance companies

Functions of the money market

1. It helps to provide capital (working capital) for the day-to-day running of businesses.
2. Investing in call money generates extra income.
3. It helps to mobilise savings.
4. It helps to promote economic growth and development.
5. It encourages good saving habits among those with surplus funds.
6. Money invested in the money market is very easy to recall.

What is the capital market?

Funds are needed by entrepreneurs, government and business firms on a long-term basis. The money market cannot provide these funds, so the capital market bridges this gap. A capital market is a market where long-term securities are traded.

Instruments used in the capital market

The instruments are securities such as shares, stocks, development stock, bonds and debentures.

• Share: A unit of capital measured by a sum of money. It is an individual portion of the company’s capital owned by a shareholder. It is a means of raising long-term capital for companies through the stock exchange market.
• Stock: A bundle of shares or mass capital which can be transferred in fractional amounts. Stocks are always fully paid, for example, stocks can be quoted per ₦100 nominal value. They are collections of shares into a bundle. Stocks are not issued but converted from shares issued.
• Development stock: A debt instrument through which governments get long-term loans or borrowing for a period of five years and above.
• Bond: An interest-bearing or discounted government or corporate security that obliges the issuer to pay the bondholder a specified sum of money annually at a specific interval and to repay the principal amount of the loan at maturity.
• Debenture: An instrument or a loan certificate for raising a long-term loan from the public by a limited company. A debenture is a debt, so the debenture holder is a creditor and not a co-owner of the business.

Institutions involved in the capital market

1. Issuing houses
2. Insurance companies
3. Development banks
4. Building societies
5. National Provident Fund (NPF)
6. Stock exchange

Functions of the capital market

1. It provides long-term loans for investment.
2. It serves as a forum through which the public sector takes part in running the economy.
3. It helps to mobilise savings for investment purposes.
4. It provides a means through which merchant banks can grow and develop.
5. It gives the general public an opportunity to participate in the running of the economy of the country.

Evaluation

1. Define the money market and the capital market.
2. List four instruments used in the money market.
3. State two differences between a treasury bill and a treasury certificate.
4. Explain the terms share, stock and debenture.
5. State three functions of the capital market.

Assignment

1. A government treasury bill is a form of debt instrument which falls due for repayment after: (a) 3 months (b) 9 months (c) 2 years (d) 5 years (e) 10 or more years.
2. Long-term loans can be secured from: (a) commercial banks (b) discount houses (c) development banks (d) acceptance houses.
3. In the money market, money can only be borrowed for: (a) long-term (b) short term (c) capital projects (d) public utilities.
4. The debt instrument through which a loan can be secured for a period of five years and above is: (a) debenture (b) share (c) stock (d) bond.
5. Call money funds are a debt instrument used in: (a) stock exchange market (b) money market (c) foreign exchange market (d) capital market.