Foreign Exchange Volatility and Financial Performance of Bond Market in Kenya
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Date
2025-10
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Kenyatta University
Abstract
Bond markets play a crucial role in the economy by influencing interest rates, facilitating government and corporate borrowing, and signaling economic health. Its movements directly impact borrowing costs for consumers and businesses, and it serves as a key indicator for investors and policymakers alike. However, foreign exchange rate volatility has characterized the Kenyan market environment leading to effects on the markets. This study explored the interrelation between financial performance and foreign exchange volatility of bond markets in Kenya. The precise goal was to investigate the effect of inflation, money supply and interest rate on bond markets performance from a financial perspective. The period of study was from 2010 to 2023. The research was underpinned on the interest rate parity theory, quantity theory of money, monetary theory of inflation, and modern portfolio theory. The research utilized a causal research design and targeted 26 institutions from various sectors including banks, investment Firms, pension funds and insurance. A census was employed in analyzing these institutions. Data collection was done using a secondary data collection tool and the analysis was done using a panel regression model with the aid of Stata version 14. Descriptive statistics, correlation analysis and inferential statistics were conducted. The diagnostic tests which include normality test, heteroscedasticity test and multicollinearity tests were equally carried out. A Hausman test was done to determine whether a fixed effect or a random effect model will be applied in the study. Finally, the study adhered to the ethical considerations throughout the period of study. The findings also indicate that the R2 (coefficient of determination) is 0.694 implying that 69.4 percent of the changes in bond market turnover is explained by inflationary changes, interest rates and money supply. The findings from panel regression analysis indicate an inverse and significant relationship between inflation and bond market turnover holding other variables constant. The outcome from panel regression analysis indicates that interest rates and bond market turnover have a significant and positive relationship. The regression analysis shows that money supply has a positive effect on bond market turnover, holding other factors constant. The study concludes that foreign exchange volatility components (inflation, interest rates and money supply) have a significant effect on bond market turnover. Specifically, inflation has a major and negative correlation with bond market turnover, hence an increase in inflation negatively and significantly influences bond turnover. The study also concludes that interest rates have an important and positive impact on bond market turnover implying that rise in interest rates results in an increase in bond market turnover holding other variables constant. Finally, the study concludes that supply of money has a positive but insignificant effect on bond market turnover. The study recommends that investors should closely monitor inflation rates. Understanding these factors can assist investors make well-versed decisions about when to enter or exit bond positions based on anticipated changes in currency values. Investors should use financial instruments like forward contracts, options, or futures, to guard against unfavorable movements. This strategy helps ensure that inflationary effects do not erode the returns from the bond investment. Regarding the significance of interest rates in bond markets, the study recommends that in volatile markets, focusing on short-term bonds may be advantageous as they typically have less sensitivity to interest rate changes compared to long-term bonds. Additionally, extending duration strategically during periods of expected rate cuts will enhance returns while managing risks associated with foreign exchange fluctuations.
Description
A Research Project Submitted to the School of Business, Economics and Tourism in Partial Fulfilment of the Requirement for the Award of the Degree of Master of Business Administration (Finance) of Kenyatta University, October 2025
Supervisor:
1.Vincent Mutswenje