The money and bond markets in a nutshell
The money market is usually defined as the market for short-term debt instruments and the bond market as the market for long-term debt instruments. However, the money market is more than this. It is comprised of the following markets:
• The primary markets that bring together the supply of retail and wholesale short-term funds and the demand for wholesale and retail short-term funds.
• The secondary market in which existing marketable short-term instruments are traded.
• The creation of new money (deposits) and the financial assets that lead to this (loans in the form of NMD and MD securities).
• The central bank-to-bank interbank market (cb2b IBM) and the bank-to-central bank interbank market (b2cb IBM) where monetary policy is played out and interest rates have their genesis (i.e. where repo is implemented).
• The b2b IBM where the repo rate has its secondary impact, i.e. on the interbank rate.
• The money market derivative markets (= an addendum).
Thus the money market plays a crucial role in the economy including, as we shall see, in the equity market. As far as financial instruments are concerned it is essentially the short-term debt market (NMD and MD). The debt market's long-term arm is the long-term debt market and this is where the bond market fits. Unlike the money market where NMD and MD are included, in the bond market only long-term MD is included, which is the definition of bonds. Bonds are only issued by prime borrowers: government, prostates, SPVs and large companies that have ratings acceptable to lenders / investors.
Essence of the equity market
The equity market is part of the capital market (= bond and equity markets). The capital market is the market in which prime borrowers are able to access long-term and/or permanent funding. Two notes are required here:
• We also use the term "borrowers" for the issuers of equity because equity includes preference shares which in many markets are redeemable. (Strictly speaking an ordinary share represents part-ownership and not a debt of a company.)
• Equity is actually a wider concept that includes retained profits (reserves), but we use it to denote the marketable shares of listed companies.
We define the equity market as follows:
The equity market is the mechanisms / conventions that exist for the issue of, investing in, and the trading of marketable equity instruments that represent the permanent or semi-permanent capital of the issuers (companies).
If this definition is dissected, we arrive at the following key words:
• Market mechanism.
• Issue (primary market).
• Trading (secondary market).
• Permanent or semi-permanent capital of the issuers.
Each of these key words will be explained briefly.
Equities (also called shares in this text) are issued by companies in terms of the statute that regulates them (usually called the Companies Act) and there are two types:
• Ordinary shares (also called common shares or common stock) that represent the permanent capital of companies; they have no maturity date (as such they are much like perpetual bonds).
• Preference shares (also called preferred shares or preferred stock). These shares may be redeemable (i.e. have a fixed maturity date), redeemable at the option of the issuer or non-redeemable (have no maturity date). The latter are sometimes called perpetual preference shares.
Shares pay dividends, as opposed to bonds and money market instruments that pay interest. Dividends on preference shares are usually fixed-rate dividends and they have preference over dividends on ordinary shares (explained in more detail later).