Money market versus capital market, and their instruments

One line, drawn at issue

Debt securities are sorted into two markets by term to maturity when they were issued. Anything issued with one year or less to run is a money-market instrument; anything issued with more than a year is a capital-market instrument. The capital market also holds equities, which have no maturity at all.

The word that matters is original. A 30-year Government of Canada bond issued in 1996 has six months left today. It is traded, priced and quoted like a short bill — but it is a capital-market instrument by origin, and the paper will ask exactly this. The classification is a property of the security, not of the calendar.

The four Canadian money-market instruments

• Government of Canada Treasury bills (T-bills) — issued by the federal government at auction in 3-, 6- and 12-month terms. Sold at a discount to face value and redeemed at face; there is no coupon, and the return is the discount.
• Bankers' acceptances (BAs) — a corporate draft (a promise to pay) that a bank has accepted, stamping its own guarantee on it, so that the paper trades on the bank's credit rather than the company's. Also a discount instrument.
• Commercial paper — an unsecured short-term promissory note issued by a large, well-rated corporation directly to investors. Discount instrument; the company's own credit stands behind it.
• Term deposits and guaranteed investment certificates (GICs) — deposits with a bank or trust company for a fixed term at a fixed rate; the short ones (30 days to a year) are money-market instruments. These pay interest, not a discount.

Worked example — Maritime Ferries' treasury desk

Maritime Ferries holds $4,000,000 it will need in three to nine months. Its treasurer buys a 91-day T-bill (money market, discount), a 60-day issue of commercial paper from a rated utility (money market, discount), a 1-year GIC at a bank (money market — twelve months is at the boundary, not beyond it — and it pays interest), and, for the part of the cash the company will not need for years, a 5-year Prairie Grid Energy bond (capital market, semi-annual coupons). A colleague suggests adding a GoC bond that matures in seven months because "it is basically a bill". It is priced like one — but it is a capital-market instrument by origin, and on an exam that distinction is the whole question.

Discount versus coupon

T-bills, BAs and commercial paper pay nothing along the way. You pay less than 100 today and receive 100 at maturity; the gap, annualised, is the yield (Lesson 4.3 does the arithmetic). A bond pays a coupon — a stated interest amount, in Canada normally every six months — and returns its par at the end. A GIC is closer to the bond: it pays interest on the deposit. The money-market/capital-market split is about term; the discount/coupon split is about how the return arrives, and the two do not line up perfectly.

Six instruments to classify

(1) 182-day T-bill — money market, discount. (2) A 10-year provincial bond — capital market, coupon. (3) 90-day commercial paper — money market, discount. (4) A 3-year GIC — capital market, interest. (5) A bankers' acceptance — money market, discount. (6) Common shares — capital market, no maturity.