How different financial markets affect economy

Dr Boni Wanjau. [Courtesy]

Financial markets refers to any marketplace where financial securities trading occurs, including the stock market, bond market, forex market, derivatives market, crypto currency and commodities markets. When financial markets fail, economic disruption, including recession and rising unemployment, can result like it happened in the 2008 world financial crisis.

Stock markets are the most known of financial markets. These are investment vehicles where companies list their shares, which are bought and sold. Stock markets, or equities markets, are used by companies to raise funds.

Over 65 companies are listed on the Nairobi Securities Exchange. Share prices indeed have a significant impact on the economy. The majority of Kenyans have exposure to the stock market as they invest in these markets for their retirement plans. They invest in company shares and when share prices rise, people tend to spend more as they feel wealthier and more optimistic about the future.

Companies issue new shares to raise more funds when share prices are high. The stock market reflects the health of an economy as GDP increases hence firms experience higher profitability. 

Bond market is a security in which an investor loans money for a defined period at a pre-established interest rate. Think of a bond as an agreement between the lender and borrower containing the loan’s details and its payments. Bonds are issued by corporations as well as governments to finance projects. The bond market is also called the debt, credit, or fixed-income market.

Derivatives markets is where derivatives, which is a contract between two or more parties, where deals (quantity and price) are agreed now and executed at future date. The Nairobi securities derivative market was started in 2009. This market is still developing in African countries.

The forex or foreign exchange market is where individuals and businesses can buy, sell, hedge, and speculate on the exchange rates between different currencies. The forex market is the most liquid market in the world. A currency’s exchange rate is basically the price of one currency in terms of another currency and is typically determined by the strength or weakness of the underlying economy fundamentals, frequent fluctuations in the exchange rate disrupts international trade and cause problems in a nation’s financial system. A strong exchange rate (appreciated exchange rate) can depress economic growth because it makes exports more expensive and imports cheaper whereas a depreciated currency makes exporters earn more and imports become expensive.

Commodity prices indeed have a significant impact on the economy. Rapidly increasing commodity prices can lead to cost-push inflation as it affects consumer purchasing power. When the prices of basic commodities like energy and agricultural products increase, it affects directly the cost of living for individuals and businesses, this reduces consumption. Commodity prices also influence a country’s trade balance (exports minus imports). When a country exports goods at higher prices, it earns more foreign exchange currency and this positively impacts the balance of payments. 

Dr Boni Wanjau writer is an economist