Factors Affecting Pakistan's Bond Market

Factors Affecting the Bond Market of Pakistan 2014
Superior University Lahore | 1 | P a g e
FACTORS AFFECTING THE BOND MARKET
THESIS SUBMITTED TO
Department of commerce
Superior University Lahore
In partial fulfillment to the requirement for the degree of
(M.Com) Master in Commerce
Session 2012 – 2014
SUPERVISOR
MUHAMMAD SHAFAAT SAIF
SUBMITTEDBY
MUHAMMAD UMER KHALID
MCE-13338

DECLARATION OF ORIGINALITY
I hereby declare that this project is entirely my own work and that any additional sources of
information have been duly cited. I hereby declare that any Internet sources published or
unpublished works from which I have quoted or draw references fully in the text and in the
content list. I understand that failure to do this will result in failure of this project due to
plagiarism.
I understand I may be called for viva and if so must attend. I acknowledge that this is my
responsibility to check whether I am required to attend and that I will be available during the
viva periods.
Signed _______________
Date _______________
(Muhammad Umer Khalid)

ACKNOWLEDGEMENT
First of all I am thankful to ALLAH ALMIGHTY who in spite of all my weaknesses enabled me
to prepare this final thesis well in time. And I am also highly indebted to my respected teacher
Shafaat Saif faculty member of Superior University Lahore, whose timely help and guidance
paved a way for me to complete this thesis. It was surely their method of teaching and eagerness
for imparting knowledge that I did not find much difficulty to give in to my thoughts and
information.
I am also thankful to all those people who extended or offered to extend their help in order to
complete this thesis.

DEDICATION
I would like to dedicate this humble effort to my most loving and honorable Parents ‘Mr. and
Mrs. Khalid Mehmood’ my brother ‘Dawod Khalid’ and my friends ‘Muhammad Ahmad, Faizan
Sarfraz & Sh. Umair Ullah’. They have being with me every step of the way through good and
bad times. Thank you for all the unqualified love, guidance and support that you have always
given me, helping to succeed and instilling in me the confidence that I am capable of doing
anything I put my mind of.
Thank you for everything.

TABLE OF CONTENTS
Factors Affecting The Bond Market ............................................................................................... 1
Thesis Submitted To ................................................................................................................... 1
Supervisor ................................................................................................................................... 1
Submitted By............................................................................................................................... 1
Declaration Of Originality .............................................................................................................. 2
Acknowledgement .......................................................................................................................... 3
Dedication....................................................................................................................................... 4
Table Of Contents ........................................................................................................................... 5
Abstract ......................................................................................................................................... 10
Chapter 1....................................................................................................................................... 11
Introduction................................................................................................................................... 11
1.1 Background ......................................................................................................................... 11
1.1.1 Debt Management............................................................................................................ 15
1.2 Purpose Of Study................................................................................................................ 16
1.3 Objective Of The Study ...................................................................................................... 16
1.4 Significance Of The Study.................................................................................................. 16
1.5 Research Question............................................................................................................... 17
1.6 Theoretical Framework/ Model .......................................................................................... 17
Bond Market ............................................................................................................................. 17
Trade Deficit ............................................................................................................................. 17
Inflation..................................................................................................................................... 17
Interest Rate .............................................................................................................................. 17
1.6.1 Key Term ......................................................................................................................... 18

Bond Market ......................................................................................................................... 18
Inflation................................................................................................................................. 18
Interest Rate .......................................................................................................................... 18
Trade Deficit ......................................................................................................................... 18
1.7 Hypothesis........................................................................................................................... 19
Chapter 2....................................................................................................................................... 20
Literature Review.......................................................................................................................... 20
2.1 Relationship Between Interest Rate And Bond Market...................................................... 20
2.2 Relationship Between Inflation And Bond Market ............................................................ 22
2.3 Relationship Between Trade Deficit And Bond Market..................................................... 25
2.4 Relationship Between Interest Rate And Inflation ............................................................. 27
2.5 Relationship Between Interest Rate And Trade Deficit...................................................... 29
2.6 Relationship Between Inflation And Trade Deficit ............................................................ 34
Chapter 3....................................................................................................................................... 36
Instrument Data Methodology...................................................................................................... 36
3.1 Research Paradigms ............................................................................................................ 36
3.1.1 Positivism..................................................................................................................... 36
3.1.2 Interpretivsm................................................................................................................ 37
3.1.3 Pragmatism................................................................................................................... 37
3.2 Research Approach............................................................................................................. 37
3.2.1 Qualitative.................................................................................................................... 37
3.2.2 Quantitative.................................................................................................................. 38
3.2.3 Mixed ........................................................................................................................... 38
3.3 Population ........................................................................................................................... 38

3.3.1 Sampling ...................................................................................................................... 39
3.3.2 Sample Size.................................................................................................................. 39
3.4 Data Collection And Instrument ......................................................................................... 39
3.4.1 Method ......................................................................................................................... 39
3.4.2 Instruments................................................................................................................... 39
3.4.3 Analysis Tool............................................................................................................... 39
3.5 Data Analysis ...................................................................................................................... 40
3.5.1 Regression.................................................................................................................... 40
3.5.2 Simple Regression ....................................................................................................... 40
3.5.3 Multiple Regressions ................................................................................................... 40
3.5.4 Scatter Plot ................................................................................................................... 40
3.5.5 Histogram..................................................................................................................... 40
3.5.6 Bar Chart...................................................................................................................... 41
3.5.7 Spearmen Correlation .................................................................................................. 41
3.5.8 Pearson Correlation...................................................................................................... 41
3.6 Limitations .......................................................................................................................... 42
3.7 Ethical Consideration.......................................................................................................... 42
3.8 Future Research................................................................................................................... 43
Chapter 4....................................................................................................................................... 44
Results And Analysis.................................................................................................................... 44
4.1 Five Figure Summary ......................................................................................................... 44
Interpretation............................................................................................................................. 45
4.2 Histogram............................................................................................................................ 45
4.2.1 Current Account Balance................................................................................................. 45

Interpretations ........................................................................................................................... 45
4.2.2 Inflation Consumer Price ................................................................................................. 46
Interpretations ........................................................................................................................... 46
4.2.3 Stock Trade ...................................................................................................................... 46
Interpretation............................................................................................................................. 46
4.2.4 Rate Of Interest ................................................................................................................ 47
Interpretation............................................................................................................................. 47
4.3 Scatar Plot ........................................................................................................................... 47
4.3.1 Current Account Balance Vs. Stock Trade ...................................................................... 47
Interpretation............................................................................................................................. 48
4.3.2 Rate Of Interest Vs Inflation Consumer Price ................................................................. 48
Interpretation............................................................................................................................. 48
4.3 Correlation .......................................................................................................................... 49
4.3.1 Pearson Correlation.......................................................................................................... 49
Interpretation............................................................................................................................. 49
Interpretation............................................................................................................................. 50
4.3.2 Spearman.......................................................................................................................... 51
Interpretation............................................................................................................................. 51
4.4 Regressions ......................................................................................................................... 52
4.4.1 Multiple Regressions ....................................................................................................... 52
Interpretation............................................................................................................................. 53
4.4.2 Simple Regression ........................................................................................................... 54
Simple Regression Of Real Interest Rate.................................................................................. 54
Interpretation............................................................................................................................. 56

4.5 Simple Regression Of Current Account Balance................................................................ 56
Interpretation............................................................................................................................. 58
4.6 Simple Regression Inflation Consumer Price ..................................................................... 58
Interpretation............................................................................................................................. 60
Chapter 5....................................................................................................................................... 61
Discussion And Conclusion.......................................................................................................... 61
5.1 Discussion........................................................................................................................... 61
5.2 Conclusion .......................................................................................................................... 64
5.3 Recommendation ................................................................................................................ 65
Bibliography.................................................................................................................................. 66
Appendix....................................................................................................................................... 70

ABSTRACT
This study is conducted to examine the factors that effects bond market. To examine this impact
I have chosen inflation, interest rate, trade deficit as Independent variables and to measure the
growth of banks as I have chosen growth of bank which is dependent variable in my study. Data
is collected for eight years from world development indicators. SPSS 16.0 version is applied for
data analysis. Result is examined that data is reliable. For the policy makers and bankers this
study has a number of implications. To describe the data I have drawn five figure summaries,
Histograms and Scatter plots while to see the effect of these variables on growth of banks.
Correlation and regression test and regression line is drawn with the help of SPSS. It is conclude
after the various analyses that Independent variable has no significant and negative impact on
bond market.
Key Word: Bond Market, Return, Growth of bond market.

CHAPTER 1
INTRODUCTION
1.1 BACKGROUND
After independence in 1947, Pakistan inherited underdeveloped financial system and to start
from a scratch, various experiments and developments were due on its agenda. Initial phase was
marked with development of commercial banks in private sector and Government Financed
Development Financial Institutions. The first Stock Exchange was constituted in 1947 and State
Bank of Pakistan (Central Bank) came in to being in 1948.
The eras of financial market developments in Pakistan can broadly be segregated into 1947-
1960, 1961-1970, 1971-1990 and 1991 to date periods. The 1947-1960 period was marked with
private sector development, however this trend was overshadowed in 1961-1970 when Public
Sector Development Institutions overtook. This trend sharpened in 1971-1990 when private
sector developments altogether shrunk and banking industry came under Government control.
Post 1991 period witnessed liberalization stance of the Government and market-based reforms.
Onward 1990, market based Government Securities came in to existence. With the introduction
of long term paper in 1992 (FIBs), long term yield curve came in to being giving opportunity to
the Corporate to come up with their instruments that became reality in 1995 (Issue of First TFC),
however actual pace gained momentum onward 2000, with the introduction of long term
instrument i.e. Pakistan Investment Bonds (PIBs), but the pace is still very slow with issues still
to overcome. The basic issue at the moment is to keep regular supply of long term GOP
instruments which have been scarcely supplied in the preceding three years. This has made the
long term yield curve non representative thus increasing pressure on short term yields. As the
Sovereign Yield curve serves the purpose of providing bench mark to overall Financial Market
transactions, so the situation has hampered the growth of Fixed Income segment in Pakistan

more significantly as compared to other segments and this obstruction is needed to be removed
instantly for the development of Fixed Income Market in Pakistan.
The first long term bond issued in 1992 thus giving an opportunity to corporation to issue a bond
by taking that long term yield curve as a bond. Hence a series start in 1995 when the first term
Finance Certificate was sold in market then later on in 2000 and Pakistan Investment bonds are
sold by Government. But due to the limited supply of government s securities a representative
long-term yield curve had not formed which constrained the development of corporate bond
market.
In the 1980s and 1990s, inflation was the major factor driving down the share of long-term,
fixed-rate local currency debt. Burger and Warnock (2003, 2004), for instance, find that foreign
purchases of local currency bonds in emerging markets are negatively correlated with past
inflation performance. This finding is supported by some researchers, who find evidence that low
volatility of inflation and low levels of public debt foster the demand for local currency bonds.
(Margolin, 2007). The several announcements of bond markets tend to find relative few of them
are significant. They find that many of monthly of the monthly announcements they examine
have no significant effect on interest rate. One reason is that the daily interest rate data on which
these studies rely are not of significantly high frequency to capture the market reactions cleanly.
Some argue that ideally one should measure the market change from just before to just after the
announcements.
Another reason is that the effect of given announcement surprise may vary even over short
period of time depending on what else is going on in the economy. (Remolona, 1997) The
domestic interest rate is negative and significant only for government bonds. Interest rate
volatility is positive correlated with private bond market and negatively correlated with
government bond market. The interest rate spread is positively correlated with the corporate but
not public bond market. The opposite is found in financial bonds. According to (th.grammenos,
2005) the investment grade bonds revealed a negative relationship between credit spread and the
level of interest rates. (yibin mu, 2013) According to In Malaysia, monetary policy was used to
control the stability of the price level as well as to promote sustainable growth rate in the
country. Tracing back the history of monetary policy In Malaysia, there are many stages. Since
the seventies, the monetary policy strategy by the Central bank was monetary targeting. This is

because monetary aggregates are believed to be closely correlated with inflation. From the mid-
1990s, (THANG, 2009) According to some researcher suggests that the investment grade bonds
revealed a negative relationship between credit spread and the level of interest rates.
(th.grammenos, 2005) According to some scholars suggest that optimal maturity depends on the
ability to forecast changes in inflation and interest rate in the market. In gap from the perspective
of investor, they will in short term-term debts if the expected future market interest rate is higher
than received returns from investment in bonds thus, the yield spread of short term bonds may be
smaller than those of long term bonds. Coupon rare is the term used for the interest earned by the
investor. Bond investors prefer a low coupon rate because they can save their tax expenses. Thus,
the investor require a higher premium for a higher coupon rate (paisarn, 2006) In Malaysia,
monetary policy was used to control the stability of the price level as well as to promote
sustainable growth rate in the country. Tracing back the history of monetary policy In Malaysia,
there are many stages. Since the seventies, the monetary policy strategy by the Central bank was
monetary targeting. This is because monetary aggregates are believed to be closely correlated
with inflation. From the mid-1990s.
(THANG, 2009) They to find that the yield differentials of 39 US states relative to New Jersey
depend positively on their levels of debt. Some also use data from 12 OECD countries and show
that the differential between public and private bond yields is positively related to the level of
public debt. We uses yields of bonds issued by state governments in Australia, Canada, and
Germany and shows that yield spreads depend positively on the ratio of government debt to
GDP. Some argues suggest that consistently confirm a positive relationship between public Debt
and interest rates. We find an effect of fiscal on both interest rate spreads and the overall level in
an empirical study of euro area countries. (Bernoth, 2004).
It would stimulate import and curtails export. Thus, Malaysia as an export oriented country,
stimulating export (depreciate) will bring us more income and profit thus stock market index is
expected to increase. REER should be negatively correlated to stock market index. (THANG,
2009) In the 1970s and 1980s, however, fiscal deficits and inflationary pressures restricted
demand for these bonds at interest rates governments were willing to pay. In many cases, the
issuance of long-term, nominal fixed-rate local currency bonds disappeared. (Margolin, 2007)
The Asian Bond Market Initiative deserves our attention for at least two reasons. First,

developments related to the establishment of an Asian bond market have been much faster than
progress on the first two major ASEAN+3 agenda items. A better understanding of the reasons
for this should shed light on the key factors affecting regional cooperation outcomes. Second, the
successful establishment of an Asian bond market has tremendous implications for actors both
inside and outside the region. The initiative is inextricably linked to financial reform and
liberalization processes in all East Asian economies. It could also have a large impact on the
ability of key global economies such as the United States to continue to fund their fiscal deficits.
(Amyx, 2004) He finds that bond yields are indeed highly positively correlated with the
dividend yield and that expected inflation primary bond yield co movement reasonable for high
stock bond yield correlation. In context of rational model expected inflation must be positively
correlated with the dividend yields through some combinations of positive correlation with the
real rate and equity risk premium, or a negative correlation with expected cash flow growth. We
find that only a relative small portion of the overall component between expected inflation and
the dividend yield can be ascribed to correlation between expected inflation and real rates. A
somewhat large but still no dominant price is due to negative covariance between expected
inflation and expected cash flow. The bulk of positive covariance between dividend yield and
expected inflation comes from positive co movement between expected inflation and risk
premium. (Geert Bekaert, 2008)
An announced CPI inflation is significantly higher than the one incorporated into the current
bond futures price, there will be a fall in the bond futures price reflecting the higher inflation
expectations component of the underlying interest rate. Alternatively, a lower bond futures price
may emerge as a result of an impending tightening of the monetary policy stance aimed at
removing further inflationary pressure. The other economic variables considered are more
closely associated with economic activity, and higher than expected activity (that is, a higher
than expected CAD, GDP, Retail sales figures and a lower than expected unemployment rate)
would lead to higher real (and thus nominal) interest rates and lower bond futures prices. (Suk-
Joong Kim a, 2000) In some cases, a bond's price is affected by something that is unique to its
issuer--for example, a change in the bond's rating.
However, other factors have an impact on all bonds. The twin factors that affect a bond's price
are inflation and changing interest rates. A rise in either interest rates or the inflation rate will

tend to cause bond prices to drop. Inflation and interest rates behave similarly to bond yields,
moving in the opposite direction from bond prices. Just the opposite happens when interest rates
are falling. When rates are dropping, bonds issued today will typically pay a lower interest rate
than similar bonds issued when rates were higher. Those older bonds with higher yields become
more valuable to investors, who are willing to pay a higher price to get that greater income
stream. As a result, prices for existing bonds with higher interest rates tend to rise (Goudeau,
2012) According to some views that to focus on the effect of ESG news on bond and credit
default swap prices. They assume that negative (positive) events will increase (decrease) the
firm’s credit risk. We expect that risk-averse bondholders will reduce their exposure to riskier
firms and that the market price of their bond will drop. On the other side, positive events are
expected to reduce credit risk thus an increase (decrease) in bond market (credit default swap)
value (Berg, 2012)
1.1.1 DEBT MANAGEMENT
Pakistan’s public debt grew at an average rate of 18 percent and 15 percent per annum during the
1980s and 1990s, respectively – much faster than the growth in nominal GDP I.e. 11.9% and
13.9% respectively. Resultantly, public debt rose from 56 percent of GDP at the end of the 1970s
to 92 percent by the end of the 1980s. In other words, it increased by 36 percentage points of
GDP during the 1980s. Public debt was 85 percent of the GDP by the end of the 1990s. The root
cause of rising debt burden has been the persistence of large fiscal and current account deficits.
Pakistan, on average, sustained fiscal and current account deficits of almost 7 percent and 5
percent of GDP, respectively during 1990-99. It is in this background the Government decided to
devise new debt management strategy to arrest the rising trends of debt. Reduction in the fiscal
and current account deficits, lowering the cost of borrowing, raising revenue and foreign
exchange earnings, and debt re-profiling from the Paris Club have been the key features of the
debt reduction strategy. To provide legal cover to debt reduction strategy a Fiscal Responsibility
and Debt Limitation Act 2005 has been promulgated in June 2005. As a result of the credible
strategy being followed by the Government, the public debt- to-GDP ratio, which stood at almost
85 percent in end June 2000, declined substantially to 53.4 percent by the end of March 2007, a
decline of 28 percentage points in country’s debt burden in 7 years.

1.2 PURPOSEOF STUDY
The purpose of study will focus only on the factors affect the bond market as the aim to provide
a better understanding for investor about the bond market in Pakistan. Bond market is a good
place for investment and earning money but mostly investors don’t think which elements affect
the bond market profit. So our research is way of guidance for those investors. The most
important is that we check that inflation, interest rate and trade deficit affect the investment in
bond market. A lot of variable affect the bond market but our focus is only on these variables
because these variable can change economy of any country at any time.
1.3 OBJECTIVE OF THE STUDY
Every research must contain lot of objectives Objective of my research is that it better
understands for investor about bond market. So my topic has lot of benefits and objective that
mentioned in below that why we research on that topic factors affect the bond market.
 It is helpful for investors who invest in bond market.
 Protect investors.
 Ensure full and fair disclosure about securities
 It is helpful for the knowledge of bond market issues.
 We know that inflation impact on bond prices will be negative
 It is helpful for knowing the development in the bond market
 We know that interest rate effect on bond market so investor must consider interest rates
 Proper development in bond market can overcome inflation and trade deficit of any
country
 It also helpful about return on bonds.
1.4 SIGNIFICANCE OF THESTUDY
My topic factors affect the bond market is helpful for the following persons:
 investors
 Policy maker
 Financial institutions
 Those researcher who want to continue further this study

 This research is helpful for the country development.
 This research provides the importance for the finance student.
 This research is helpful for the country financial management.
 This research is helpful for the multinational organization.
 This research is helpful for the investors who want to expand its business.
 This research is most helpful for the financial securities institution.
 This research help the profit oriented organization for the increase of the profit.
 This is important of the firm who wants to increase the performance of the firm. That
firm dealing in securities.
 This study provides the help for expand the business.
 This study guides who to gain the market power or the hold of the market
1.5 RESEARCH QUESTION
Topic of my research is factors affect the bond market. Research question on which my study is
based is associational in nature as my topic is focuses on association between inflation and bond
market, trade deficit and bond market, interest rate and bond market.
1.6 THEORETICALFRAMEWORK/MODEL
BOND MARKET
TRADE DEFICIT
INFLATION
INTEREST RATE

1.6.1 KEYTERM
BOND MARKET
A bond is a debt capital market instrument issued by a borrower, who is then required to repay to
the lender or investor the amount borrowed plus interest over a specified period of time .There is
a wide range of parties involved in the bond markets. We can group them broadly into borrowers
and investors plus institution and individual who are the part of business of bond trading
(Moorad, 2010)
INFLATION
Inflation is a situation in which price are rising while admitting the inherently arbitrary character
of specific choice assert that an inflationary situation Is a function of two principle factors the
rate of price increase and the duration of the increase with the assumption that the faster the rate
of price increase and the longer the duration of rising prices the more appropriate is it to defined
situation as inflationary (R.J.Ball, 2007)
INTEREST RATE
Interest rate risk has been defined as the risk to profit from adverse changes that might occur in
interest rates, resulting in higher interest costs, a fall in investment income or income from
lending or a change in the market price of financial securities (Coyle, 2001)
TRADE DEFICIT
That part of a nation balance of payment dealing with imports and exports that is trade in goods
and services over a given period if export of goods exceeds imports the trade balance is said to
be favorable, if imports exceed exports the balance of trade is said to be unfavorable. The
balance of trade is the difference between the monetary value of export and imports in an
economy over a certain period of time if consist of exporting more than imported a negative
balance of trade is known as trade deficit. (Satija, 2009)

1.7 HYPOTHESIS
My topic is factors affect the bond market. Now in hypothesis we see that there is relationship
exist among variables or not. We check these relations exist in variables through literature and
data analysis. On the base of my topic there are three hypotheses are made that show in below.
H0: There is no relationship between inflation and bond market
H1: There is relationship between inflation and bond market
In the above literature we see that there is relationship between inflation and bond market,
sometimes these affect will be positive in bond market and some time that affect will be we in
bond market. So in short inflation effect on bond
H0: There is no relationship between interest rate and bond market
H2: There is relationship between interest rate and bond market
In the above literature we see that there is relationship between interest rate and bond market,
sometimes these affect will be positive in bond market and some time that affect will be negative
in bond market. So in short interest rate effect on bond market. Interest rate volatility is positive
correlated with private bond market and negatively correlated with government bond market
H0: There is relationship between trade deficit and bond market
H3: There is no relationship between trade Deficit and bond market
In the above literature we see that there is relationship between trade deficit and bond market,
sometimes these affect will be positive in bond market and some time that affect will be negative
in bond market. So in short trade deficit effect on bond market. Pakistan’s bond market has
followed a negative trend over the last 20 years in contrast to other countries in the group, which
have exhibited a steady upward trend.

CHAPTER 2
LITERATURE REVIEW
2.1 RELATIONSHIP BETWEEN INTEREST RATE AND BONDMARKET
According to (yibin mu, 2013) domestic interest rate is negative and significant only for
government bonds. When interest increase than bond will decrease and vice versa. Interest rate
volatility is positive correlated with private bond market and negatively correlated with
government bond market. The interest rate spread is positively correlated with the corporate but
not public bond market. The opposite is found in financial bonds. According to (th.grammenos,
2005) the investment grade bonds revealed a negative relationship between credit spread and the
level of interest rates. This shows that credit spread increase than investment on bond will be
decreases and vice versa.
According to (paisarn, 2006) suggest that optimal maturity depends on the ability to forecast
changes in inflation and interest rate in the market. In gap from the perspective of investor, they
will in short term-term debts if the expected future market interest rate is higher than received
returns from investment in bonds thus, the yield spread of short term bonds may be smaller than
those of long term bonds. Coupon rare is the term used for the interest earned by the investor.
Bond investors prefer a low coupon rate because they can save their tax expenses. Thus, the
investor require a higher premium for a higher coupon rate. According to (Remolona, 1997) the
several announcements of bond markets tend to find relative few of them are significant. They
find that many of monthly of the monthly announcements they examine have no significant
effect on interest rate. One reason is that the daily interest rate data on which these studies rely
are not of significantly high frequency to capture the market reactions cleanly. Some argue that
ideally one should measure the market change from just before to just after the announcements.
Another reason is that the effect of given announcement surprise may vary even over short
period of time depending on what else is going on in the economy.

According to (shi, 2003) find that no systematic relationship between the welfare level and
interest rate. When the liquidity of is interior. The interest rate and welfare are positively related
to each other when bonds liquidity low but negatively related when bond liquidity is high.
According to (V.vance Roley and Gordon H .sellon, 1995) the standard view of the monetary
policy transmission mechanism suggests a close relationship between Federal Reserve policy
action and market interest rate. However, while there is considerable evidence that monetary
policy has predicable effect on short term rates. The connection between policy action and long
term interest rate appear to be the weaker and less reliable. So long term interest rate have week
relationship between monetary policies.
According to (Radzewicz-Bak, 2008) the level of interest rates is measured by interest rate
spread (lending rates minus LIBOR). High interest rates tend to have a sad impact on issuance
and bond market development, since few firms can service debts when interest rates are high.
Interest rate variability is measured as a standard deviation of interbank interest rates. Where
interest rates are variable, investors will have little desire for long-term fixed-rate notes because
there is high risk that the purchasing power of long-term fixed-rate assets will be eroded.
Investors’ limited appetite for long-term bonds will limit the demand for securitized debt. On the
other hand, high interest rate volatility may be an indication of lack of market liquidity, as long
as returns are affected by the entrance and exit of a few buyers and sellers. A negative
relationship is expected between nominal interest rate volatility and bond market development.
According to (Michael Sherris.Sydeny) Studies of interest rate risk factors in the various bond
markets including the U.S. bond market, the Danish market and the Italian bond market have
been carried out. These studies demonstrate both similarities and differences in international
bond markets. It appears that three factors explain the major portion of yield curve. The lowest
correlation occurs between the short term interest yield and the medium to longer term yields.
The medium term yields have much. Higher correlation with the longer term yields. Based on
these correlations, it would be a surprising result if a single factor interest rate model, which
assumes all yields are perfectly correlated, were found to be an adequate basis for explaining the
future evolution of interest rates.
According to (Bernoth, 2004) find that the yield differentials of 39 US states relative to New
Jersey depend positively on their levels of debt. Some also use data from 12 OECD countries and

show that the differential between public and private bond yields is positively related to the level
of public debt. We uses yields of bonds issued by state governments in Australia, Canada, and
Germany and shows that yield spreads depend positively on the ratio of government debt to
GDP. Some argues suggest that consistently confirm a positive relationship between public debt
and interest rates. We find an effect of fiscal on both interest rate spreads and the overall level in
an empirical study of euro area countries.
2.2 RELATIONSHIP BETWEEN INFLATION AND BOND MARKET
According to (THANG, 2009) In Malaysia, monetary policy was used to control the stability of
the price level as well as to promote sustainable growth rate in the country. Tracing back the
history of monetary policy In Malaysia, there are many stages. Since the seventies, the monetary
policy strategy by the Central bank was monetary targeting. This is because monetary aggregates
are believed to be closely correlated with inflation. From the mid-1990s, According to (Corning,
2011) the first indexed treasury was issued in January 1971 with a maturity of ten year. The
most important feature of treasury inflation protected securities is that investors in these
Treasuries are protected from the risk of unexpected inflation. So investors save the risk of
investment from inflation.
According to (Berg, 2012)focus on the effect of ESG news on bond and credit default swap
prices. They assume that negative (positive) events will increase (decrease) the firm’s credit risk.
We expect that risk-averse bondholders will reduce their exposure to riskier firms and that the
market price of their bond will drop. On the other side, positive events are expected to reduce
credit risk thus an increase (decrease) in bond market (credit default swap) value. According to
(Margolin, 2007) In the 1980s and 1990s, inflation was the major factor driving down the share
of long-term, fixed-rate local currency debt. Burger and Warnock (2003, 2004), for instance,
find that foreign purchases of local currency bonds in emerging markets are negatively correlated
with past inflation performance. This finding is supported by some researchers, who find
evidence that low volatility of inflation and low levels of public debt foster the demand for local
currency bonds.
According to (Norliza Ahmad, 2009) it is revealed that the interest rates were found to have
negative impact on the yield spread of USD denominated Malaysian bonds. Some argues and

supported this finding by stating that the inverse relationship between market rates of interest
rate and bond prices in which the increase in interest rate will cause in the decrease of bond
prices. Intuitively, the decrease in bond prices will translate into the widening of the yield spread
and vice versa. According to (CAMPBELL, 2009) in recent years government issued inflation
indexed bonds have become available in a number of countries and have provided a
fundamentally new instrument for use in retirement saving. Because expected inflation varies
over time, conventional, non-indexed (nominal) Treasury bonds are not safe in real terms; and
because short-term real interest rates vary over time, Treasury bills are not safe assets for long-
term investors. Inflation indexed bonds fill this gap by offering a truly riskless long-term
investment .Second, in recent years inflation-indexed bond prices have tended to move opposite
to stock prices, so that these bonds have a negative “beta” with the stock market and can be used
to hedge risk. This has been even truer of prices on nominal government bonds, although these
bonds behaved very differently in the 1970s and 1980 in recent years inflation index bond prices
have tended to move opposite to these stock prices. So that these bonds have negative beta with
stock market.
According to (th.grammenos, 2005) There is only study that has investigated a shipping initial
offering in the bond market. He examined the primary pricing of high yield bond offering in
shipping industry during the period 1993-1998. Someone also examined the high yield new bond
issuing prices in Europe. According to (Pindyck, 1983) suggest that Increases in the expected
rate of inflation have been accompanied by increases in the variance of that rate, and this can
also affect the variance of stockholders' returns. First, inflation affects net real returns directly
through the tax system, so that volatility of inflation causes volatility in these returns. Second, is
that there is a negative correlation between unanticipated inflation and stock returns. We do not
explain that correlation; as has shown, it may in part be an indirect one occurring through
correlations with real economic variables. However, it implies a negative correlation between
unanticipated inflation and the gross marginal return on capital, so that volatility of inflation will
be associated with volatility in that gross return.
According to (paisarn, 2006) he suggests that Inflation rate impact directly on treasury bills.
Whenever expected inflation increase coupon rate on Treasury bill would be higher than that
expected inflation rate. When the inflation increases, return on treasury bills will increase

simultaneously. As a result the corporate bond will have a narrow spreads over a similar
government securities. According to (Geert Bekaert, 2008) he finds that bond yields are indeed
highly positively correlated with the dividend yield and that expected inflation primary bond
yield co movement reasonable for high stock bond yield correlation. In context of rational model
expected inflation must be positively correlated with the dividend yields through some
combinations of positive correlation with the real rate and equity risk premium, or a negative
correlation with expected cash flow growth. We find that only a relative small portion of the
overall component between expected inflation and the dividend yield can be ascribed to
correlation between expected inflation and real rates. A somewhat large but still no dominant
price is due to negative covariance between expected inflation and expected cash flow. The bulk
of positive covariance between dividend yield and expected inflation comes from positive co
movement between expected inflation and risk premium.
According to (Rodionova) In china the influence of inflation is not verified in short run and in
long run the full fisher affect is not found. Rare studies of other emerging markets (Argentina
India Thailand) also do no reveal long term relationship between yields and current inflation
what was explained as a result of a non-constant real interest rate. According to (Ralph Chami,
1999) Inflation has negative contemporaneous correlation of-0.65 with real stock return
reflecting the stock channel. Some authors evidence exist that both inflation and expected
inflation have negative impact on real stock return. Some found that contemporaneous
correlation of -0.25 for the United States based on monthly data. They also found similar results
in Chile, Korea, Taiwan, during higher inflationary period.
According to (Suk-Joong Kim a, 2000) if an announced CPI inflation is significantly higher than
the one incorporated into the current bond futures price, there will be a fall in the bond futures
price reflecting the higher inflation expectations component of the underlying interest rate.
Alternatively, a lower bond futures price may emerge as a result of an impending tightening of
the monetary policy stance aimed at removing further inflationary pressure. The other economic
variables considered are more closely associated with economic activity, and higher than
expected activity (that is, a higher than expected CAD, GDP, Retail sales figures and a lower
than expected unemployment rate) would lead to higher real (and thus nominal) interest rates and
lower bond futures prices. According to (Giuliano Iannotta, 2006) Corporate bonds in both

euro area countries and non-euro area countries, they revert the amount of bond issues on
country and year dummies, as well as on an indicator variable for countries which joined the
single currency. They find that the euro has a positive and significant effect on the number of
bond issues.
2.3 RELATIONSHIP BETWEEN TRADE DEFICIT AND BOND MARKET
According to (Ryo Onodera, 2012) Japan's fiscal balance has been failing, and the government
has become increasingly dependent on deficit covering bonds. Most of the issued Japanese
government bonds (92% as of September 2011) are held by domestic investors, including banks,
insurers, and public pension funds. However, if Japan's current account falls into a deficit,
surplus funds or savings retained by the private and household sectors would also diminish. In
addition, it would be increasingly difficult for domestic investors to take up the majority of
Japanese government bonds issuances. As Japan's population ages rapidly, the number of
domestic investors who invest their savings in Japanese government bonds would also decrease.
Increasing dependence on foreign funds would result in negative consequences such as greater
interest rate volatility. Muted demand for JGBs may also drag down the price of JGBs, and
accordingly, push up the bonds' yields to maturity. This, in turn, would drive interest rates
higher. Country is 3x that in a current-account surplus country. (Note: Functions of long-term
interest rates—-namely the rate of increase of long-term interest rates--are estimated by using
causal factors as variables. These factors include short-term interest rates, price increase rate,
GDP growth rate, and fiscal balance. Bond market has impact on GDP of different countries see
appendix.
According to (THANG, 2009) It would stimulate import and curtails export. Thus, Malaysia as
an export oriented country, stimulating export (depreciate) will bring us more income and profit
thus stock market index is expected to increase. REER should be negatively correlated to stock
market index. According to (Margolin, 2007) In the 1970s and 1980s, however, fiscal deficits
and inflationary pressures restricted demand for these bonds at interest rates governments were
willing to pay. In many cases, the issuance of long-term, nominal fixed-rate local currency bonds
disappeared. According to (Amyx, 2004) The Asian Bond Market Initiative deserves our
attention for at least two reasons. First, developments related to the establishment of an Asian
bond market have been much faster than progress on the first two major ASEAN+3 agenda

items. A better understanding of the reasons for this should shed light on the key factors
affecting regional cooperation outcomes. Second, the successful establishment of an Asian bond
market has tremendous implications for actors both inside and outside the region. The initiative
is inextricably linked to financial reform and liberalization processes in all East Asian
economies. It could also have a large impact on the ability of key global economies such as the
United States to continue to fund their fiscal deficits.
According to (Uppal, 2011) The Open Budget Index (2010) a project of the International Budget
Partnership provides another method of assessing fiscal management in 94 countries. The index
rating for Pakistan is at 38 percent. The report notes that there is “minimal” openness in the
budget process. Compare Pakistan’s rating with a group of selected countries. It is shows that,
except for Pakistan, all these countries improved their overall Open Budget Index rating over the
three surveys. Pakistan’s bond market has followed a negative trend over the last 20 years in
contrast to other countries in the group, which have exhibited a steady upward trend. The
positive trend followed by the Indian bond market stands in sharp contrast to the market in
Pakistan. As the Indian bond market has grown over time, it has also assumed greater depth. This
is indicated by the growth in bonds issued by financial institutions and domestic corporations.
According to (Klingebiel) the share of foreign currency denominated bonds over total bonds.
This shows that emerging market economies are increasingly issuing government bonds in
currencies other than their own, from a mean share of 9.2 percent in 1993 to 26.8 percent in
1998, with a decline to 22.8 percent in 2000. On the contrary, developed countries show a
declining trend in the share of foreign currency bonds, from 21.8 percent to 15.5 percent over the
same period. Though not reported, there are differences across countries. A large increase in
foreign currency borrowing takes place for Latin American countries, from a mean of 4.3 percent
in 1993 to 46.9 percent in 1996, declining somewhat to 35.6 percent in 2000, with a high in 2000
of 95.3 percent for Argentina. In Europe, transition economies also start to issue relatively more
debt in foreign currency towards the end of the decade. The share of foreign currency bonds is
the lowest for Germany and the U.S.
According to (Schou-Zibell, 2008) the need to finance a large fiscal deficit has stimulated
issuance and growth of the government bond market. Since 1992, deficit finance has relied
increasingly on borrowing from the market rather than the previous policy of monetizing the

deficit. The government market comprises approximately 104 issues with a total nominal value
of about USD364 billion The corporate bond market is less developed than most in emerging
East Asia, with private placements dominating. At 3.9% of GDP, corporate bonds are
comparable to levels in the Philippines and Indonesia, where corporate finance is less well-
developed, as well as with the People’s Republic of China (PRC) and Viet Nam, where state-
ownership remains dominant. That said, corporate bond markets remain small in much of the
region with the exception of the Republic of Korea (Korea) and Hong Kong, China. Even in
absolute terms India’s corporate bond market is minuscule in relation to its economic size. The
role of various sources of corporate finance demonstrates that there is no single model for
corporate finance some economies rely more heavily on equity finance, while others more on
bank finance. However, few rely so little on corporate bonds as India does.
2.4 RELATIONSHIP BETWEEN INTEREST RATE AND INFLATION
According to (Gürkaynak, 2006) says reveal substantial cross-country differences in the
sensitivity of forward nominal interest rates and inflation compensation to economic news. For
the United States, we find that later forward nominal rates and inflation compensation have
exhibited highly significant responses to important economic announcements. Moreover, these
responses are systematic in the sense that they are consistent with financial markets perceiving
some degree of (or some chance of) pass through from inflation in the near term to inflation at
very long horizons. For the United Kingdom, we find very similar results to those for the U.S.
prior to the Bank of England gaining independence in mid-1997, but after Bank of England
independence, we find that far-ahead forward nominal rates and inflation compensation in the
U.K. have been invariant with respect to economic news.
According to (sarig, 1996) argues that deterministic changes in inflation expectations cause
equal changes in nominal interest rate in nominal interest rate leaving the real interest rate
unaffected. In stochastic setting we interpret the fisher hypothesis to mean that real interest rate
process and inflation process are independent of each other. In particular the real interest rate
process neither changes across regimes nor depends on inflation within each regime. We find
that inflation expectation and ax ante real rates of interest are negatively correlated. Some
suggests that because inflation gains are taxed as if they were real gains. The after tax real
interest declines when inflation expectation increases.

According to (A. & HARDOUVELIS, IX) the short-term interest rate reactions to the CPI and
PPI announcements were previously analyzed by them. They find a positive but insignificant
response. Some examining refined time intervals are able to find a statistically significant
delayed response to the WI announcement during the afternoon of the day of the announcement
(the announcement takes place in the morning). These authors have attributed the30 Economic
Stews, Exchange Rater and Incrust Rater response of short-term interest rates to revisions of
inflationary expectations. But the response could also be due to changes in the risk-free real rate
of interest as the Fed may be expected to counteract past increases in the rate of inflation. The
twenty-year T-bond rate and the exchange rates of the present paper can provide evidence that
allows us to discriminate between these two competing hypotheses. The expected inflation
hypothesis predicts a depreciation of the dollar and an increase in long-term interest rates that is
larger the more permanent the increase in inflation is expected to be. The expected liquidity
hypothesis predicts an appreciation of the dollar and an increase in long term interest rates that is
much smaller than the observed increase in short term interest rates because the liquidity effect
disappears in the long run.
According to (Fernando, Robert, & Warren, 2001) Many theoretical models have been
introduced in the last few years, designed to rationalize the use of interest rate policies to control
inflation rates. Many of these are centered on a class of policies known as “Taylor rules,” rules
that specify the interest rate set by the central bank as an increasing function of the inflation rate
(or perhaps of a forecast of the inflation rate).1 Theories differ considerably in their specification
of the economy to which the Taylor rule is assumed to apply.
According to (Fernando, Robert, & Warren, 2001) these observations need not rule out a
constructive role for the use of short term interest rates as a monetary instrument. One possibility
is that increasing short rates in the face of increases in inflation is just an indirect way of
reducing money growth: Sell bonds and take money out of the system. Another possibility is that
while control of monetary aggregates is the key to low long run average inflation rates, an
interest rate policy can improve the short run behavior of interest rates and prices. The short run
connections between money growth and inflation and interest rates are very unreliable, so there
is much room for improvement. These possibilities are surely worth exploring, but doing so

requires new theory: The analysis needed to reconcile interest rate policies with the evidence on
which the quantity theory of money is grounded cannot be found in old textbook diagrams.
According to (shmuel, 1996) we find that inflation expectation and ax ante real rates of interest
are negatively correlated in fisher hypothesis. It shows that increase in expected inflation
increase in capital stock and reduce the return on capital. Some suggest that because inflation
gains are taxes as if they were real gains the after tax real rate of interest decline when inflation
expectation increases. Some suggest that because investor uncertain about monetary policy. Real
interest rates are negatively correlated with inflation. When inflation and output is negatively
correlated.
According to (Goudeau, 2012) in some cases, a bond's price is affected by something that is
unique to its issuer--for example, a change in the bond's rating. However, other factors have an
impact on all bonds. The twin factors that affect a bond's price are inflation and changing interest
rates. A rise in either interest rates or the inflation rate will tend to cause bond prices to drop.
Inflation and interest rates behave similarly to bond yields, moving in the opposite direction from
bond prices. Just the opposite happens when interest rates are falling. When rates are dropping,
bonds issued today will typically pay a lower interest rate than similar bonds issued when rates
were higher. Those older bonds with higher yields become more valuable to investors, who are
willing to pay a higher price to get that greater income stream. As a result, prices for existing
bonds with higher interest rates tend to rise.
2.5 RELATIONSHIP BETWEEN INTEREST RATE AND TRADE DEFICIT
Cebula (1988) tests for relationship between deficits and nominal yield on average Moody's Aaa
bond. Uses 2SLS estimation and GDP trend to rid deficit of cyclical components. Finds deficit
has significantly positive association with long-term rates. Raynold (1994) argues that the reason
why we have had poor relationships between deficits and interest rates is because tests have
ignored liquidity constraints. He finds that if he excludes these, deficits have no significant effect
on interest rates; but when these variables are included, deficits have significant negative effects
on interest rates. (Ussher, 1998)
According to (Mojekwu, 2011) revealed a positive relationship between interest rate and fiscal
deficits. They argue that increasing reliance on domestic financial markets for financing

government deficits is likely to lead to steep increases in interest costs. However some suggests
that fiscal deficits have a significant impact on interest rate in Nigeria. Interest rates are not
controlled, high fiscal deficits are correlated with strongly negative real interest rates, and the
loss of access to external borrowing for financing fiscal deficits often leads to higher taxes on
domestic financial intermediation. This phenomenon can even lead to stagnant or declining
economic growth.
According to (Ryo Onodera, 2012) In estimating the uplift from a fiscal deficit on long-term
interest rates, the coefficients in current-account surplus and deficit nations are 0.076 and 0.263,
respectively.) If we apply Japan's fiscal deficit (which accounted for 9.6% of GDP) in the year
ended Dec. 31, 2011, to the aforementioned formula, under a scenario in which the positive
current account turns negative, the long-term interest rate would increase about 1.8% (in this
case, factors other than the fiscal deficit are regarded as invariables).Japan's long-term interest
rate rose about 3% per year in 1989-1990. Although Japan has not seen its long-term interest rate
rise more than 1.8% since then, it is still meaningful to study how higher long-term interest rates
would affect Japanese banks' financial bases, in our view. Specifically, we believe it is
meaningful to base our test calculations on the assumption that Japan's long-term interest rate
would rise 1.8% for bonds of all maturities, amid a current account deficit. A rise in JGB interest
rates could trap the government in a vicious circle: a heavier interest payment burden would
require the government to issue more new bonds or even deficit-covering bonds, which may, in
turn, worsen its fiscal balance, inviting another round of rate hikes. Under such circumstances,
the sovereign ratings could come under pressure. Given that the relationship between bank
ratings and the sovereign rating is strong, higher interest rates of JGBs could hurt Japanese fiscal
balance may indirectly affect the ratings on domestic banks. The Cabinet Office of the Japanese
government has analyzed the key drivers behind the long-term interest rates of the member
nations of Organization for Economic Co-operation and Development (OECD) in its White
Paper on Economy and Public Finance published in July 2010. According to the paper, the
estimated impact (or upward pressure) of the fiscal-deficit-to-GDP-growth-rate ratio on long-
term interest rates in a current-account deficit

According to (silva, 2008) larger fiscal deficits are associated with large government bond
market. The fiscal balances are all positive and significant while the quality of bureaucracy and
interest rate spread are negative and significant. The fiscal balance is robust with higher deficits
leading to larger bond market.
According to (tsuranuki) he suggests that Sovereign bond charge highly indebted countries with
premium interest rates in purchasing their bonds. Premium is called the spread over the German
ten years bonds. At the premium interest rate investors are ready to switch purchasing from the
bond to more indebted countries ten years bonds. These countries are differentially charged with
highest interest rates because of there excessive budget deficit and debts. Their negative
externalities are thus charged prices dearly
According to (Weber, August 2012) find that long term bonds yield having higher fiscal deficit
and public debt raises interest rates. Some reports from out of 59 from 29 find that weaker fiscal
variables increase interest rates. While 11 reports had mixed results while 19 found that the
affect was not significant. Majority of researchers find that the affect of fiscal policy on interest
rate is larger when the fiscal deficit rather than public debt. They estimated impact on interest
rate of a change of one percent of GDP in fiscal deficit ranges from 10 basis points to 60 basis
points
According to (Faiza saleem, 2012) rise in interest rate increase in demand for domestic
currency in the market for foreign exchange causing the currency to appreciate. The appreciation
in currency in turn affects trade in goods and services. With the stronger currency domestic
goods are more expensive for foreigners and foreign goods are cheaper for domestic residents.
Export fall. Import rise and the trade balance moves towards deficits.
According to (Eric M.Engen, 2005) some argues that equivalence catalog problem with the test
of hypothesis performed by examining the relationship between Federal Government debt and
deficit with interest rate. Some conclude that it is easy to cite a large number of studies support
that any conceivable position however in the end. An author generally fined more overall support
for the above equivalence hypothesis which implies government debt and deficit has no effect on
interest rates. Some authors argue and rejected these hypotheses. And suggest that positive
relationship between Government debt and deficit with interest rates. Many researchers take a
similar position as above authors. Overall the empirical results on interest rates support the view.

Given these findings it is remarkable that most macroeconomists remain confident that budget
deficit raises interest rates. Our view is that the existing evidence is quite mixed. Some studies
find positive effects of federal deficits on interest rates; others do not. Even among the studies
that do find a positive effect of deficits on interest rates, the magnitude of the effect on interest
rates is still uncertain. In their analysis of the G7 countries, they find no evidence of a positive
and significant relationship between home-country current debt or deficits and current interest
rates, similar to many authors and they find that one-year-ahead forecasts of home country
government deficits by the OECD tend to have a significant negative effect on nominal short-
term interest rates, in contrast to the prediction of the government deficit crowding out
hypothesis. However, one year ahead forecasts of other country government deficits by the
OECD tend to have a significant effect on home country nominal102.Some argues that short-
term interest rates in the direction consistent with the government deficit crowding-out
hypothesis.
According to (Wray, 1997) argues that high interest rate increase Government deficit through
direct and indirect impact. A high interest rate increases government expenditure adding directly
to the government deficit. As this increase borrowing and outstanding debt stock these interest
payment become a permanent component of the government budget that can only be reduced
only by lowering interest cost or by running government surplus that allow a portion of the debt
to be retired. If high interest rates slow the economy. Then deficit indirectly increased as tax
revenues fall and many types of spending rise. When interest rates rise then as private lending
declines spending declines lowering government revenue and increasing the budget deficit. The
direct effects of high interest rate policy are significant in every OECD countries.
According to (Uppal, 2011) find that countries reduce their primary deficits as a reaction to
high debt servicing costs. Many scholars have examined the magnitude of the impact of fiscal
deficits and public debt on long-term interest rates, and the extent to which it is influenced by
other factors such as the private savings rate, demographics, the quality of institutions, and
international financial integration. In the neo classical model, large fiscal deficits create an
excess supply of government debt, leading to higher real interest rates. The yield curve also
becomes positively sloped in anticipation of continuing large fiscal deficits. If combined with
increased economic uncertainty, fiscal deficits could also raise concerns about the government’s

ability to service its debts and raise credit risk premiums. Higher inflation expectations and
concerns about the monetization of debt increase the inflation premiums embodied in the
nominal rates. Some factors may weaken the link between fiscal deficits and interest rates. For
instance, capital inflows may complement domestic savings in an open economy for some time
by leading to real exchange rate appreciation rather than higher real interest rates. For many
reasons, the results of many studies remain mixed. Survey almost 60 studies and find in around
half of them a “predominantly positive significant” effect of fiscal deficits on interest rates, and
in the other half a “mixed” or “predominantly insignificant” effect. A recent study assesses
empirically the impact of fiscal deficits and public debt on long-term interest rates over almost
three decades, taking into account a wide range of country specific factors, for a panel of 31
advanced and emerging market economies. Their key finding is that “the impact of fiscal
deterioration on long-term interest rate is significant and robust but nonlinear. Moreover, the
magnitude of the impact reflects initial fiscal, institutional and structural conditions, as well as
spillovers from global financial markets.” Baldacci and Kumar note in particular that
“differences in institutional
Features and domestic private saving rates also play a role in determining the impact of deficits
on interest rates. According to (Yusen Liu, 2005) country may have negative trade balance in
goods, positive balance in service, and because the negative imbalance in goods is greater than
positive imbalance in service the overall trade balance is still in negative. Such is the case with
the US’s trade balance. When adding the US trade balances of goods and service after 1971, the
positive balance in service, improves the picture of the overall US trade balance by somewhat
offsetting the negative balance in goods. The US trade deficit leads to higher interests rates in
the US. Because a large amount of US dollars needed for the domestic market are paid for
imports to foreign exporters, there is a shortage of US dollars left for borrower and investment in
the domestic market. Therefore, the value of the dollar has been bid up, and interest rates have
risen. If the US trade deficit had not been so large, US interests rates would have been lower.
According to (Niskanen, 1988) relation between interest rates and exchange rates is more
complex than is usually recognized. Specifically, the difference between the current and forward
exchange rate with respect to another currency tends to equal the difference between domestic
and foreign interest rates. An increase in domestic interest rates will increase the current

exchange rate by an equal amount only when the forward exchange rate does not change, such as
when the increase in the domestic interest rate is expected to be temporary. This relation, called
the “covered parity” condition, is strongly consistent with the evidence and was about the same
in the late 1970s and the early 1980s. In both periods, changes in the current and forward
exchange rates were closely related, explaining why there has been so little relation between
interest rates and exchange rates. The combined effect of these first two links does not appear to
be significant. In other words, there does not appear to be any significant direct effect of budget
deficits on exchange rates. Final the relation between the real exchange rate and the real trade
deficit has also turned out to be weaker than expected. The economist’s characteristic hypothesis
about the relation between the foreign and government balances is based on the following
sequence of effects: Real budget deficits increase real interest rates, which increase the real
exchange rate, which increases the real trade deficit.
According to (THANG, 2009) expected relationship between bond market index and interest
rate is that they are negatively correlated. When the interest rate is low, the stock market index
will increase and vice versa. This is because the investors are shifting their money from their
savings or fixed deposit account to the bond market in order to gain a higher return. Another
investment instrument which compete with investment in the bond market. From 1997 to 2008,
interest rate in Malaysia has gradually decreased from 9.65% (1998) to the sideway range
between 2%-4% (from 1999-2008). In 2009, Malaysia monetary policy has confirmed that the
overnight policy rate will be retained as 2.00. Interest rate has negative impact on the stock
market in Ghana. Interest rate has negative impact on the stock market index in Japan. There is
insignificant relationship between Japanese bond prices and interest rate,
2.6 RELATIONSHIP BETWEEN INFLATION AND TRADE DEFICIT
According to (Stanisław Kluza1, 2002) The improved liquidity of the T-bond market in Poland
were illustrated by the bond price behavior in the first half of 2002, when the rise in bond prices
(due to expected interest cuts) were not stopped by the considerable increase in their supply due
to the higher budget deficit According to (silva, 2008) Macro Economics perspective inflation
affects foreign currency inflow and country competitiveness adversely. If domestic inflation is
higher than those of others countries, a country export will be less competitive and hence in less

demand in international market. There will also be less foreign currency inflows through foreign
direct inflows and portfolio flows. These again negatively impact on overall bond market.
According to (silva, 2008) Macroeconomic perspective inflation affects foreign currency inflow
and country’s competitiveness adversely. If domestic inflation is higher than those other
countries. Country’s exports will be less competitive and hence in less demand in international
markets. There will also be less foreign currency inflow through foreign direct inflow and
portfolio flows. So there is again negative impact on the overall bond market.
According to (Faiza saleem, 2012) Budget deficit increases the trade deficits (that reduce net
exports). Budget deficit also affect stock prices through expected future taxes. Some suggest that
large budget deficit increase inflation rate. The co integration analysis provides that both budget
deficit and inflation have negative impact on stock prices. Whether changes in deficit cause
changes in stock prices and if so, in what direction. The study use co- integration techniques and
Granger causality test to assess the long run causal relationship between budget deficits and
stock prices in Pakistan and Indian.
According to (tyson, 1998) the notion that there is a tradeoff between price inflation and the rate
of growth of output comes from 1958 by British economist. Who observed that there is negative
relationship between wage inflation price and unemployment rate in UK data from 1861 to1957.
When dollar has been appreciated contributing downward pressure on input cost as well as final
goods price. First the weighted exchange value of dollar appreciated some 25 percent from mid-
1995 through mid-1999. This appreciation of dollar tended to reduce imports prices. On the
export side sales abroad have had to contend not only with an appreciating dollar but also with
slow activity in other economics. Export prices declined particularly sharply in 1997and 1998
until the dollar began depreciated in late in the year. But rise in labor cost in the past servile
years has not been passed through to increase inflation prices. It is general relationship between
price inflation rate and growth of output rate.
According to (Uppal, 2011) argues that reductions in budget deficits may help to control the
level of prices. An empirical analysis of many authors suggests that inflation in Pakistan is not
only related to fiscal imbalances but also to the sources of financing fiscal deficit and, therefore,
the fiscal sector is dominant in explaining price movements.

CHAPTER 3
INSTRUMENT DATA METHODOLOGY
3.1 RESEARCHPARADIGMS
3.1.1 POSITIVISM
The positivist approach to scientific inquiry emerged as a reaction to the metaphysically based
philosophy of science that characterized science up to the age of enlightenment which lasted
from roughly 1600 to 1800. Before ten knowledge that was developed under ecclesiastical
sponsorship was ascribed to supernatural or deific forces (trochim2002) this science was
fashioned on a belief that everything in the world was created by God and everything in the
world was as God wanted to it be. People could not hope to know why things existed or how
they came to be (other than as a creation of god). Rather they could only observe the world and
its many phenomena as it existed. The positivist reaction to metaphysical science was
empiricism. Empiricism means that all knowledge must be send (seen felt heard measured) to be
real faith alone the idea of knowing something is true because you believe it to be true was an
insufficient basis for explaining a phenomenon or as a foundation for knowledge. The idea of
phenomenon cannot be measured they should not be studied was a logical extension of this
reaction to metaphysics. These early positivists also believed that the goal of all science natural
and social is to describe everything that can be experienced. Positivist proposed cause and effect
theories about phenomena and then framed those theories in a way that they could be stated as
hypotheses which could then be tested. The preferred method of testing a hypothesis was to
conduct an experiment in which variables were manipulated that is their values changed and the
result observed recorded (Mcnabb, 2010)

3.1.2 INTERPRETIVSM
The specific context in which people live focus by the interpretive researcher and where people
work to understand the cultural and historical settings of participants. To understand the meaning
of phenomena, their subjective views and formed through participant, this time make this
paradigm at the time when participant provide understanding, from their own personal histories.
“From bottom to up” shaped is form of inquiry research according to broad patterns and
ultimately from individual’s perspective. There are some weaknesses of interpretive such as
quantitative predictions are difficult to make, to test hypotheses and theories is more difficult.
There is more time is required to collect data when compared to quantitative research (jonsons,
2004).
3.1.3 PRAGMATISM
With mixed method research pragmatism is associated. Replace of approaches is not the goal of
pragmatism but rather to draw from minimize the weakness and from strength of both in single
research studies (Johnson & Onwuegbuzie, 2004). Answer the questions which is asked is
primary importance thus focus is on consequences rather than the method problem under the
study multiple method of data collections. It is work on “what work” and “solutions to
problems”. Problem is most important rather than method all approaches are used by the
researcher to understand the problems (Patton, 1990; Tashakkori and Teddlie, 1998)
3.2 RESEARCHAPPROACH
3.2.1 QUALITATIVE
Qualitative research is a research approach that usually emphasizes words rather than
quantification in the collection and analysis of data.
General aims of qualitative research:
 To add understanding to a phenomenon or the complexities of human behavior
 It does not claim to generalize
 To generate theory therefore it is inductive rather than deductive

3.2.2 QUANTITATIVE
Quantitative research is about quantifying relationship between variables. A more scientific
approach to defining quantitative research comes from hussar men descriptions of the
quantitative research typically discern a cycle of successive phases of hypothesis formulation
data collection analysis and interpretation using a deductive approach quantitative research seek
to establish facts make prediction and test hypotheses that have already been stated. And from a
marketing perspective quantitative research is most useful in gathering measurable information
that can be tracked over time. Almost all definitions go on to point out the difference between or
contrast quantitative research with qualitative research. This is helpful to the marketer because
the comparisons help delineate not only the advantages and disadvantages but also the
applications most appropriate for various research approach. Quantitative research is said to have
primary advantages. The first is that it allow. The moderator or interviewer for interviewer for
interaction with respondents. It allow for the interactions between respondent (group member).
This interaction often simulates discussion that uncovers issues unanticipated during the design
phase.(Ronald A. Nykiel, 2007)
3.2.3 MIXED
A mixed methods approach is one in which the researcher tends to base knowledge, claims on
pragmatic grounds (e.g., consequence-oriented, problem-centered, and pluralistic). It employs
strategies of inquiry that involve collecting data either simultaneously or sequentially to best
understand research problem. The data collection also involves gathering both numeric
information (e.g., on instruments) as well as text information (e.g., on interview) so that the final
database represents both quantitative and qualitative information.
3.3 POPULATION
Populations mean that total people who live in a country boundary. But in that place Population
mean that total people who are related to our research. My research topic factors affect the bond
market is related only financial institution and financial market like banking sectors, cooperation
financial institutions, bond market, securities company , stock markets etc. in short my research
population is financial institution of country. In simple words Samples means we select data

from population. But according to my topic my population is financial institution or financial
markets so we select data from world development indicators as a sample of my population.
3.3.1 SAMPLING
I will use the bond market from financial institution, but according to my topic my population is
financial institution or financial markets so we select data from world development indicators as
a sample of my population.
3.3.2 SAMPLE SIZE
We take eight years data from world development indicator as a sample size of my variables like
inflation, interest rate, trade deficit and bond market.
3.4 DATA COLLECTION AND INSTRUMENT
Data collection will be on two sources one is primary source and other is secondary source.
Primary source will use only when data of secondary source is not suitable for our topic. For
primary source we make questioner as instrument for data collection from people who are
relevant of our topic. We collect data through secondary source for data analysis. Because these
data available in world development indicator as we required for data analysis of my research is
suitable. We chose secondary source because data about my topic is suitable and available in
world development indicators.
3.4.1 METHOD
We use quantitative method for my research for data analysis. We use quantitative data for data
analysis.
3.4.2 Instruments
My topic is related to financial institution so we use world development indicators as an
instrument.
3.4.3 ANALYSIS TOOL
I will use the most efficient & proper tool for the analysis of data. And the best software for the
analysis of quantitative data is (SPSS) software.

3.5 DATA ANALYSIS
3.5.1 REGRESSION
Regression analysis measures the nature and extent of the relation between two or more
variables, thus enables us to make predictions. (HIrsch, 2010)
3.5.2 SIMPLE REGRESSION
We apply regression analysis to simple linear relationship between the dependent Y variables
and one independent X variables. By linear we mean that the variable Y is assumed to be
influenced by variables X in the following manner. Where a is constant and b is regression
coefficient and e is error (Terry J Watsham, 1997)
Y = a + b(x) + c
3.5.3 MULTIPLE REGRESSIONS
Rarely is the behavior of dependent variables explained by just one independent variable.
Usually several independent variables, used in combination, offer the best explanation. A
regression model incorporating several independent variables is known as multiple regressions.
The relationship between the dependent variable Y and the various independent variables the X1
is given by (Terry J Watsham, 1997).
Y = a + b1x1 + b2x2 + bnxn + e
3.5.4 SCATTER PLOT
Many times we can learn how to improve a situation or solve a problem by collecting data on
only one characteristic such as the time to complete an order or number of defects. Other times,
we can learn even more by looking at the relationship between two characteristic for instance it
might be that time to complete an order has an effect on the numbers of defect as the process
goes faster perhaps the number of defects increases (jioner, 1995)
3.5.5 HISTOGRAM
A histogram for a discrete numerical data is a graph of the frequency or relatively frequency
distribution and it is similar to the bar chart for categorical data. Each frequency or relative

frequency is represented by a rectangle centered over the corresponding value (or range of
values) and the area of the rectangle is proportional to the corresponding frequency or relative
frequency. A histogram is said to be unmade if it has a single pack. Bimodal if it has two peaks.
And multimodal if it has more than two peaks. (Roxy Peck, 2011)
3.5.6 BAR CHART
Bar chart along with pie chart are among the most popular graphical representation of tables
however they are less useful than dot plot in most situations. A bar chart analogous to the dot
plot is produced. In fact bar chart can actually mislead when the origin is arbitrary, as they
convey the incorrect impression that the quantity encoded by the length of bar has some
meaning. Another popular but questionable practice is add to confidence intervals to bar chart
dot plot with confidence intervals are almost invariably easier to interpret. (sarkar, 2008)
3.5.7 SPEARMEN CORRELATION
This is finding the correlation coefficient between two variables was developed by the British
psychologist Charles Edward spearmen in 1904. This method is applied to measures the
association between two variables when only ordinal data are available. In other words this
method is applied in a situation in which quantitative measures of certain qualitative factors
cannot be fixed. But individual observation can be arranged in a definite order. (Called rank) the
ranking is decided by using a set of ordinal rank numbers with 1 for individual observation rank
first either in terms of quantitative and qualitative and n for the individual observation rank last
in group of a pairs of observations. (Sharama, 2007)
3.5.8 PEARSON CORRELATION
Pearson sample correlation coefficient measures the strength of any linear relationship between
two numerical variables. It does this by using z scores in clever way. Consider replacing each x
value by corresponding z scores. And similarly replacing each y values by its z scores. Note that
x values that are larger than x bar value will have positive z scores and those smaller than x bar
will have negative z scores. Pearson sample correlation of coefficient is based on the sum of the
product of zx and zy for each observation in bivariate data set. (Roxy Peck, 2011)

3.6 LIMITATIONS
We have many limitations about my topics factors affect the bond market. So we work on these
limitations. These limitations affect the bond market.
 We take only five to ten years data from world development indicators but not taken
many years data from world development indicators.
 Research will be conduct on both way qualitative and quantitative but we use only
quantitative research approach.
 This research is only focus on Pakistan bond market but not in the whole world bond
market.
 According to this research is only on financial institution but there are so many
institutions in any country economy.
 It is also the limitation that we cannot manipulate data that we take from world
development indicator.
 We follow all the norms and values of society that’s relate to my topic factors affect the
bond market.
 This research is mostly work on private sectors but in Government sectors
 We work only on secondary source of data it is also limits of my topic
 We work only on boundary of Pakistan so this is also limit of my topic.
 We not work on primary source because this is limit about my topic of my studies.
3.7 ETHICALCONSIDERATION
Ethical consideration is that my research before or after or now but not wrong effect on any
physical mentally and financially for any company. We have secondary source of data. We
follow ethics for conducting any activity of my research. We are taking data from world
development indicator but ethically we not manipulate data that taken from world development
indicator. We show that same results as appears in the actual in the financial market. We follow
ethics on conducting all stages of my research. In short my research will be on manners and
provide actual results in the financial markets. In other way my research provide true situation
about financial market people for in investment guide.

3.8 FUTURE RESEARCH
I am determining bond market of Pakistan with the help of Interest rate, Inflation, Trade deficit
but there are also many variables which can be used in future for determining real bond rate like
inflation rate, interest rate, and stock market, my study will help researcher in future for
achieving their objectives.

CHAPTER 4
RESULTS AND ANALYSIS
In this chapter we make analysis of our data. This chapter is very important for his study because
we see how much model affects each other after different applications. We have three
independent variables that are inflation (consumer price), Trade deficit (balance of trade),
interest rate (real interest rate) and the dependent variable is bond market (current account
balance). In this chapter we check relationship between these variables or not .we check how
much dependent these variables each others. We also see them how much correlates each others.
4.1 FIVE FIGURE SUMMARY
Statistics
CAB ST ICP RI
N Valid 9 9 9 9
Missing 0 0 0 0
Mean -2.7778 2.1242E2 10.5193 -.2128
Median -2.0000 1.7352E2 9.0633 .4773
Mode -1.00 28.59a 2.91a -4.48a
Minimum -10.00 28.59 2.91 -4.48
Maximum 4.00 497.40 20.29 3.82
Percentiles 25 -5.5000 59.5628 7.5217 -3.0701
50 -2.0000 1.7352E2 9.0633 .4773
75 -1.0000 3.5022E2 13.7645 1.7045
a. Multiple modes exist. The smallest value is shown

INTERPRETATION
Firstly we apply the five figure summary on our data. This table shows mean median mode and
maximum minimum values of each dependent and independent variables. The above table shows
the results of five figure summary. First variables Real interest rate having mean -.2128,
median.4773, mode -4.48 minimum value -4.48 and maximum value is 3.82. Second variable is
inflation consumer price which produce mean 10.5193, median 9.0633, mode 2.91, minimum
2.91, maximum value is 20.29.Third variable is stock traded which having mean-2.1242,
median1.7352, mode 28.59 , minimum28.59 and maximum is497.40. Fourth variables is having
results of mean-2.7778, median-2.0000, mode-1.00, minimum-10.00 maximum value is 4.00.
4.2 HISTOGRAM
4.2.1 CURRENTACCOUNT BALANCE
We apply histogram on all dependent and independent variables. We have three independent
variables and one dependent variables. These tell us linear relationship is there or not. When bell
shape in diagram is there than linear otherwise not.
INTERPRETATIONS
This diagram shows that on x axis is current account balance but on y axis is frequencies there.
Histogram of current account balance shows the bell slope of this diagram. It is normal curve
that show the linear relationship in current account balance. It is normal curve.

4.2.2 INFLATION CONSUMER PRICE
INTERPRETATIONS
This diagram shows that on y axis is frequency and x axis is inflation consumer price. Histogram
of inflation consumer price is having bell slope. It is normal curve that show the linear
relationship in inflation consumer price. It is normal curve.
4.2.3 STOCK TRADE
INTERPRETATION
This diagram shows that on y axis is frequency and x axis is dependent variable stock traded is
there. Histogram of stock traded is having bell slope. It is normal curve that show the linear
relationship in stock traded. It is normal curve.

4.2.4 RATE OF INTEREST
INTERPRETATION
This diagram shows that on y axis is frequency and x axis is real interest rate is there. The
diagram of histogram shows bell slope. It is normal curve that show the linear relationship in real
interest rate.
4.3 SCATAR PLOT
4.3.1 CURRENTACCOUNT BALANCEVS. STOCK TRADE

INTERPRETATION
We apply Scatter plot on his data analysis to check the correlates apply on our variables.
This diagram of Scatter plot shows that there is no linear relationship stock traded and current
account balance. This diagram shows that (0.28-0.154=0.126) is greater than 0.05 so in that
variables we applicable spearmen correlation. Because line is move in diagram zero to X axis so
this shows that we apply on stock traded.
4.3.2 RATE OF INTEREST VS INFLATION CONSUMER PRICE
INTERPRETATION
This diagram of Scatter plot shows that there is linear relationship Real interest rate and inflation
consumer price. This diagram shows that (0.351-0.35=0.001) is less than 0.05 so in that variables
we applicable Pearson correlation. Because line is move in diagram y axis to X axis so this
shows that we apply is spearmen on inflation consumer price and real interest rate

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