Chapter 8 Market risk

Chapter 8 Market risk

Market risk is the risk of losses in positions arising from movements in market prices

The risk that a major natural disaster will cause a decline in the market as a whole is an example of market risk. The main sources of market risk are: foreign exchange rates, equity prices, interest rates, commodities.

Market risk framework

There are two sources of market risk, those generated by transactions and those generated by the composition of the balance sheet, including off-balance sheet positions.

Transaction exposures is the risk, faced by companies involved in international trade, that currency exchange rates will change after the companies have already entered into financial obligations. Such exposure to fluctuating exchange rates can lead to major losses for firms. A Foreign exchange risk can also arise from having revenues in one currency and expenses in another.

Risk Appetite is a method to help guide an organization’s approach to risk and risk management.

Simplest Metrics – Exposures and Stop-Loss

A stop-loss limit indicates an amount of money that a portfolio’s single-period market loss should not exceed. For example if the limit is 14,000, the position has to be reduce. Limit violation occurs whenever a portfolio’s single-period market loss exceeds a stop-loss limit.

The intermediate sophistication metrics involve decomposing the source of price movement into a number of factors

Market liquidity risk is the risk that a firm cannot easily offset or eliminate a position at the market price because of inadequate market depth or a market disruption. Market liquidity risk can become an issue due to the composition of the firm's portfolio or due to external factors.

Chapter 9 Operational Risk

The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. An example giving by the book was the software failures affecting networks of ATM machines, miss-selling products, and affects customers. Operational risk can be also summarized as human risk; it is the risk of business operations failing due to human error

The seven events categories:

Internal Fraud External Fraud Employee Practices & Workplace Safety Clients, Products & Business Practices Natural Disasters & Public Safety Technology & Infrastructure Failure Execution, Delivery & Process Management.

Preventable risks are those over which the firm can exercise preventative control, for example employee practices and workplace safety. External risks are those outside the sphere of influence of the firm, for example natural disasters.

Operational risk estimation:

Estimating the amount of risk is necessary as part of the risk appetite monitoring activities.

Indicators- basic indicator approach and the standardized approach. For these two approaches , the average gross income is scaled by a factor to arrive at the capital estimate. The use

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