Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices.
The associated market risk is:
Equity risk, the risk that stock prices and/or the implied volatility will change.
Interest rate risk, the risk that interest rates and/or the implied volatility will change.
Currency risk, the risk that foreign exchange rates and/or the implied volatility will change.
Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil) and/or implied volatility will change.
Equity risk, the risk that stock prices and/or the implied volatility will change.
Interest rate risk, the risk that interest rates and/or the implied volatility will change.
Currency risk, the risk that foreign exchange rates and/or the implied volatility will change.
Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil) and/or implied volatility will change.
Measuring the potential loss amount due to market risk
As with other forms of risk, the potential loss amount due to market risk may be measured in a number of ways or conventions. Traditionally, one convention is to use Value at Risk. The conventions of using Value at risk is well established and accepted in the short-term risk management practice.
However, 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 specified period. Over short time horizons, this limiting assumption is often regarded as reasonable. However, over longer time horizons, many of the positions in the portfolio may have been changed. The Value at Risk of the unchanged portfolio is no longer relevant.
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.
Rating factors
Market risk is based primarily on the following evaluation factors:
· Sensitivity to adverse changes in interest rates, foreign exchange rates, commodity prices, fixed assets
· Nature of the operations of the bank
· Trends in the foreign currencies exposure
· Changes in the value of the fixed assets of the bank
· Importance of real estate assets resulting from loans write off
· Ability of management to identify measure and control the market risks given the bank exposure to these risks
Composite rating:
The composite rating assigned is not an arithmetic average of the component ratings, but is based on a qualitative analysis of the factors comprising each component, the interrelationship between components, and the overall level of supervisory concern about the bank.
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