The Volatility Effects of Foreign Exchange on Financial Performance of the Bond Markets in Kenya

Abstract

The recent macroeconomic environment has been characterized by depreciation of the Kenya Shilling to one of the lowest levels, trading at 106 per US dollar in 2015. The NSE share index declined recording a return of 3.8% in 2014. Bonds, however have outperformed other asset classes at the N.S.E. of the recent past. In 2015, treasury bonds yielded an upward of 8.5%. The yields of both Treasury and corporate bonds have been attributed to the high interest rates recorded in the last half of 2015. The strong performance of the bond markets was attributed to high interest rates which indicates uncertainties in the markets, depreciation of the local currency and decline in returns from the stock markets with many listed companies reporting profit warning. The objective of this study is to evaluate whether the exchange rate parameter is a determinant of investments in bond markets in Kenya. Kluza (2002) finds chaotic results in analysis of the relationship between the two variables with some showing a negative relationship while others a positive relationship. Chinn and Meridith (2004) found varying results using different bond maturities. Longei (2017) who examined the relationship between USD/KES exchange rate and the NSE bond index found a negative relationship between the variables which conflicts with studies by Froot (1990) who found a positive relationship between the variables. Secondary data was collected from Bloomberg on the FTSE-NSE Kenya Government bond index for the period 2007-2017. Data on foreign exchange volatility was obtained from Central Bank of Kenya (CBK) website and statistical abstract for the period. Inflation data was obtained from the Consumer Price Indices published by Kenya National Bureau of Statistics (KNBS) for the period under study. From the results, the correlation coefficients between bond indices and the independent variables are all negative. The correlation coefficient between bond indices and FX volatility is -0.224. This implies a negative association where a unit change in FX volatility results in 22.4% change in the value of bond indices.