Definitions

adverse circumstance

Market risk

Market risk is the risk that the value of an investment will decrease due to moves in market factors. The five standard market risk factors are:

Measuring

As with other forms of risk, market risk may be measured in a number of ways. Traditionally, this is done 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 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 two factors: the probability an adverse circumstance will come about and the cost of such adverse circumstance.

References

  • Dorfman, Mark S. (1997). Introduction to Risk Management and Insurance (6th ed.). Prentice Hall. ISBN 0-13-752106-5.

See also

External links

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