Interconnectedness of capital Market

A capital market is the part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term investments. Stock market (Share Market) is a place where buyers and sellers indulge in trade (buying/selling) of financial securities like bonds, stocks, etc. The trading is undertaken by participants such as individuals and institutions. Capital market trades mostly in long-term securities and money market another component of the financial market trades in short-term securities such as treasury bills, commercial papers, and certificates of deposit.

The Stock Exchanges around the world are interconnected.  Market strength from the Dow Jones, and S&P 500 tends to flow into the Asian markets led by Japan’s Nikkei, South Korea’s KOSPI, India’s Sensex, and Nifty 100.  Chinese market indexes Hang Seng and Hong Kong tend to fluctuate between positive and negative correlations with the rest of Asia and the U.S.

While a direct relationship may not be apparent, it’s the ripple effects from a small market disruption that can transcend into different asset classes and capital markets that can trigger larger risk events leading to systemic risk affecting all economies.

On July 2, 1997, Thailand devalued its currency relating to the U.S. dollar. This development, which followed months of speculative pressures that had substantially depleted Thailand’s official foreign exchange reserves, marked the beginning of a deep financial crisis across much of East Asia and, in turn, capital market prices.

The subprime mortgage crisis was triggered by risky lending practices. When interest rates froze and the housing bubble began to collapse, borrowers couldn’t afford their payments. As massive foreclosures ensued, the fallout spread to the global financial system including the capital market.

The prices of stocks and bonds are interconnected. When stock prices rise, bond prices fall, and vice versa. Historically, when stock prices are rising and more people are buying to capitalize on that growth, bond prices have typically fallen on lower demand. On the other hand, when stock prices are falling and investors want to turn to traditionally lower-risk, lower-return investments such as bonds, their demand increases, and in turn, their prices.

Another example of the interconnectedness of the capital market is the inverse relation between Stocks and Bonds. The bond performance is closely tied to interest rates. For example, if you buy a bond with an 8% yield, it could become more valuable if the interest rate is low. This is because when the interest rate is low, the newly issued bonds would have a lower yield than the bonds issued earlier at 8%. In reverse, higher interest rates on newly issued bonds could mean newly issued bonds have a higher yield than the bonds issued earlier at 8% yield, and the earlier issued bond becomes low in value. In such a situation, many investors will dump low-yielding bonds in favour of stocks expecting potentially higher returns. The more investors buy stocks, dumping low-yielding bonds, the share prices could go up.

Similarly, when inflation rises, rising costs and uncertain revenue growth can take a toll on corporate profit margins, and stock prices can fall in response. On a broader scale, high inflation creates unknowns about future interest rates. That uncertainty often contributes to market volatility.

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