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Information about Market Risk

Market risk is the risk that the value of an investment will decrease due to moves in market factors. The four standard market risk factors are:
  • Equity risk, or the risk that stock prices will change.
  • Interest rate risk, or the risk that interest rates will change.
  • Currency risk, or the risk that foreign exchange rates will change.
  • Commodity risk, or the risk that commodity prices (i.e. grains, metals, etc.) will change.
Sometimes, a fifth risk factor is also considered:
  • Equity index risk, or the risk that stock or other index prices will change.

Measuring

Market risk is typically measured using a Value at Risk methodology. Value at risk is well established as a risk management technique, but it contains a number of limiting assumptions that constrain its accuracy. The first assumption is that the composition of the portfolio measured remains unchanged over the single period of the model. For short time horizons, this limiting assumption is often regarded as acceptable. For longer time horizons, many of the transactions in the portfolio may mature during the modeling period. Intervening cash flow, embedded options, changes in floating rate interest rates, and so on are ignored in this single period modeling technique.

Market risk can also be contrasted with Specific risk, which measures the risk of a decrease in ones investment due to a change in a specific industry or sector, as opposed to a market-wide move.

Use in annual reports of U.S. corporations

In the United States, a section on market risk is mandated by the SEC[1] in all annual reports submitted on Form 10-K. The company must detail how its own results may depend directly on financial markets. This is designed to show, for example, an investor who believes he is investing in a normal milk company, that the company is in fact also carrying out non-dairy activities such as investing in complex derivatives or foreign exchange futures.

Risk management

All businesses take risks based on the two factors: the probability an adverse circumstance will come about and the cost of such adverse circumstance.

References

1. ^ FAQ on the United States SEC Market Disclosure Rules
  • Dorfman, Mark S. (1997). Introduction to Risk Management and Insurance (6th ed.). Prentice Hall. ISBN 0-13-752106-5. 

See also

External links

Equity risk is the risk that one's investments will depreciate because of stock market dynamics causing one to lose money.

The measure of risk used in the equity markets is typically the standard deviation of a security's price over a number of periods.
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Interest rate risk is the risk that the relative value of an interest-bearing asset, such as a loan or a bond, will worsen due to an interest rate increase. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa.
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Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.
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Commodity risk refers to the uncertainties of future market values and of the size of the future income, caused by the fluctuation in the prices of commodities. These commodities may be grains, metals, gas, electricity etc.
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Value at Risk (VaR) is the maximum loss not exceeded with a given probability defined as the confidence level, over a given period of time. It is commonly used by security houses or investment banks to measure the market risk of their asset portfolios (market value at risk
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In finance, a specific risk is a risk that affects a very small number of assets. This is sometimes referred to as "unsystematic risk". In a balanced portfolio of assets there'd be a spread between general market risk and risks specific to individual components of that portfolio.
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Motto
"In God We Trust"   (since 1956)
"E Pluribus Unum"   ("From Many, One"; Latin, traditional)
Anthem
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United States Securities and Exchange Commission (commonly known as the SEC) is a United States government agency having primary responsibility for enforcing the federal securities laws and regulating the securities industry/stock market.
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A Form 10-K is an annual report required by the U.S. Securities and Exchange Commission (SEC), that gives a comprehensive summary of a public company's performance. Although similarly named, the annual report on Form 10-K is distinct from the often glossy "annual report to
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In finance, systemic risk describes the likelihood of the collapse of a financial system, such as a general stock market crash or a joint breakdown of the banking system. As such, it is a type of "aggregate risk" as opposed to "idiosyncratic risk", which is specific to individual
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Credit risk is the risk of loss due to a debtor's non-payment of a loan or other line of credit (either the principal or interest (coupon) or both).

Faced by lenders to consumers

Main article: Consumer credit risk

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Legal and regulatory risk: Sometimes governments change the law in a way that adversely affects a bank's position.

The Risk Principle

The Risk Principle is an area of law closely tied to legal causation in negligence.
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Liquidity risk arises from situations in which a party interested in trading an asset cannot do it because nobody in the market wants to trade that asset. Liquidity risk becomes particularly important to parties who are about to hold or currently hold an asset, since it affects
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operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. Although the risks apply to any organisation in business it is of particular relevance to the banking regime where regulators are
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Risk modeling refers to the use of formal econometric techniques to determine the aggregate risk in a financial portfolio. Risk modeling is one of many subtasks within the broader area of financial modeling.
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Risk aversion is a concept in economics, finance, and psychology related to the behaviour of consumers and investors under uncertainty. Risk aversion is the reluctance of a person to accept a bargain with an uncertain payoff rather than another bargain with a more certain, but
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