Financial Management · The nature and role of financial markets and institutions

Money Markets and Capital Markets for ACCA FM

Updated 11 October 2026 · Fact-checked

The **money market** is where governments, banks and companies borrow and lend for short periods, usually up to one year, using instruments such as treasury bills, commercial paper and certificates of deposit. The **capital market** deals in long-term finance: shares and bonds. To answer questions, match the need's time horizon and risk to the right market and instrument.

Understand Money Markets and Capital Markets

Every business needs finance, and every investor with spare cash needs somewhere to put it. Financial markets bring the two together. The key split is by time: short-term money against long-term money.

The money market deals in short-term borrowing and lending, typically up to one year. It is a wholesale market: deals are large and between institutions such as banks, governments and big companies. Instruments are usually low risk and highly liquid. Companies use it to manage cash: they borrow to cover a temporary shortfall or deposit surplus cash for a short time.

The main money market instruments are:

Treasury bills: issued by governments at a discount to face value and repaid at face value on maturity. They carry very low default risk. The investor's return is the gap between the price paid and the face value.
Commercial paper: unsecured short-term promissory notes issued by large, creditworthy companies, usually at a discount. It is cheaper than a bank loan but only available to firms with a strong credit rating.
Certificates of deposit (CDs): certificates issued by banks to show that a sum has been deposited for a fixed term at a stated rate. Many CDs are negotiable, so the holder can sell them before maturity.

The capital market deals in long-term finance, meaning more than one year, including permanent equity. Companies raise equity (shares) and debt (bonds, loan notes) here to fund long-term investment such as plant, expansion or acquisitions. Risk and return are higher and prices move more.

Capital markets have two parts. In the primary market, new securities are issued and the money goes to the issuer, for example through a rights issue, public offer or new bond issue. In the secondary market, existing securities are traded between investors, for example on a stock exchange. The issuer receives no cash from secondary trades. Yet the secondary market matters because it gives investors liquidity, which makes them willing to buy in the primary market, and it produces a share price that shows how the market values the firm.

Key rules to remember

Discount instrument: price: Price = Face value × (1 − d × n ÷ 365); d is the quoted discount rate and n the days to maturity. Use this only if the question quotes a discount rate. Use the day-count given in the question if it differs from 365.
Discount instrument: return over the period: Return = (Face value − Price) ÷ Price; Divide by the price paid, not by face value. This is the actual yield for the period held.
Annualised simple yield: Annual yield = Return over period × (365 ÷ n); Simple annualisation. For compound annual equivalent use (1 + return)^(365 ÷ n) − 1.
Money market versus capital market: Money market: up to 1 year. Capital market: over 1 year.; This is the usual dividing line. Treat it as the standard rule of thumb for exam answers.

How to solve Money Markets and Capital Markets questions

Questions on this topic are either descriptive (compare, identify or explain) or a short calculation on a discount instrument. Use the same routine each time.

1Read the scenario and note the time horizon of the need: a temporary cash gap or surplus, or long-term investment funding.
2Decide the market: up to one year points to the money market, longer points to the capital market.
3Identify who is borrowing or investing: government, bank, strongly rated company or a smaller firm. This tells you which instrument is available.
4Match the instrument: treasury bill for government, commercial paper for large rated companies, CD for bank deposits, shares or bonds for long-term funding.
5If a calculation is needed, find the price or the return using the discount formula and check which figure is the denominator.
6Annualise only if the question asks for an annual rate, and use the day-count stated.
7Finish with a short reason that links back to the scenario, such as liquidity, risk, cost or the issuer's credit rating.

Quickest way: Time horizon, then issuer, then instrument

When to use it: Use this for Section A and Section B objective test questions, where you have about two minutes per question and no partial marks.

Ask one question first: is the need under one year or over one year?
Under one year: scan the options for treasury bill, commercial paper or CD. Over one year: look for equity or bonds.
Eliminate options that mismatch the issuer. Treasury bills come from governments, CDs from banks, commercial paper from large companies.
For primary versus secondary, ask whether the issuer receives the cash. If yes, primary. If investors trade with each other, secondary.
For a discount calculation, compute (Face − Price) ÷ Price, then multiply by 365 ÷ days if annual.

Common mistakes in Money Markets and Capital Markets

Saying the issuing company receives money when its shares are traded on the stock exchange.
Students mix up the primary and secondary markets because both involve buying shares.
Fix: Only a new issue brings cash to the company. A trade between investors in the secondary market changes the owner of the share, not the company's funds.
Calculating the yield on a discount instrument as discount ÷ face value.
The quoted figure is based on face value, so it feels natural to use it as the denominator.
Fix: Actual return is (Face − Price) ÷ Price. The investor's outlay is the price, so divide by the price.
Treating commercial paper as available to any business.
Students focus on it being cheaper than a bank loan and overlook the conditions.
Fix: It is unsecured, so only large companies with a strong credit rating can issue it. Smaller firms normally use overdrafts or bank loans.
Describing treasury bills as risk-free in absolute terms.
Textbooks stress that they have very low default risk.
Fix: Say they have very low default risk. Holders still face small price or interest rate effects if sold before maturity.
Forgetting to annualise, or annualising with the wrong number of days.
Students rush to the first return figure they calculate.
Fix: Check whether the question asks for a period return or an annual rate. Then multiply by 365 ÷ n using the day-count given.
Writing that secondary markets are unimportant because the company gets no cash.
Students focus on cash flow to the issuer only.
Fix: Explain that secondary markets give liquidity, which supports primary issues, and provide a price that guides valuation and the cost of capital.

Worked examples

Example 1

A company buys a 91-day treasury bill with a face value of $1,000,000 for $990,000. Calculate the return over the 91 days and the simple annualised yield, using a 365-day year. Give answers to two decimal places.

Show the solution

Gain on the bill = $1,000,000 − $990,000 = $10,000.
Return over the period = 10,000 ÷ 990,000 = 0.010101, which is 1.01%.
Annualisation factor = 365 ÷ 91 = 4.010989.
Simple annual yield = 0.010101 × 4.010989 = 0.040515, which is 4.05%.

Answer: Return over 91 days is 1.01% and the simple annualised yield is 4.05%.

Example 2

Mira Co is a large, strongly rated listed company. It needs $5 million for 6 months to cover a seasonal cash shortfall. Separately, it plans a new factory costing $40 million with a useful life of 20 years. Recommend the market and a suitable source of finance for each need, and explain why a secondary market matters for the second one.

Show the solution

Seasonal shortfall: the need lasts 6 months, which is under one year, so use the money market.
Mira is large and strongly rated, so it can issue commercial paper, which is usually cheaper than a bank loan. A bank overdraft or short-term loan is the alternative.
Factory: the asset lasts 20 years, so match it with long-term finance from the capital market, such as a rights issue of equity or a long-term bond.
Matching the term of finance to the life of the asset avoids having to refinance short-term debt repeatedly.
Secondary market: investors in new shares or bonds can later sell them to other investors. This liquidity makes them more willing to subscribe in the primary market and can lower Mira's cost of raising finance.

Answer: Use commercial paper (money market) for the 6-month shortfall and long-term equity or bonds (capital market, primary issue) for the factory. The secondary market gives investors liquidity, which supports the primary issue.

Exam tips

In Section A, decide the time horizon first. Most money market versus capital market questions can be answered from this alone.
Learn one line for each instrument: who issues it, whether it is secured, and whether it is sold at a discount. Options often differ on exactly one of these.
For discount calculations, write the denominator on the page before dividing. Since objective questions give no partial marks, one wrong denominator costs the whole answer.
In a written answer, link every point to the scenario, such as the issuer's rating, the amount and the period. A generic list of features scores poorly.
Be ready to explain why liquidity in secondary markets helps primary issues. It is a common step up from simple definitions.

Practice questions from The nature and role of financial markets and institutions

Money Markets and Capital Markets in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Money Markets and Capital Markets: frequently asked questions

What is the main difference between the money market and the capital market?

The money market deals in short-term finance, usually up to one year, through instruments like treasury bills, commercial paper and CDs. The capital market deals in long-term finance, such as shares and bonds. Money market instruments are generally lower risk and more liquid.

What are the primary and secondary markets?

The primary market is where new securities are issued and the issuer receives the cash. The secondary market is where existing securities are traded between investors. The issuer receives nothing from secondary trades, but the market provides liquidity and a share price.

Why do companies use commercial paper instead of a bank loan?

It is often cheaper than bank borrowing and can be raised flexibly for short periods. However, it is unsecured, so only large companies with a strong credit rating can normally issue it.

How is a treasury bill's return calculated?

A treasury bill is bought at a discount and repaid at face value. The return is (face value − price) ÷ price. To annualise it simply, multiply by 365 divided by the number of days to maturity.