This article may require cleanup to meet Wikipedia's quality standards. Please improve this article if you can. (January 2008)

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 are:

• 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.

Contents 1 Measuring the potential loss amount due to market risk 2 Use in annual reports of U.S. corporations 3 Risk management 4 References 5 See also 6 External links

[edit] 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.

In addition, care has to be taken regarding the intervening cash flow, embedded options, changes in floating rate interest rates of the financial positions in the portfolio. They cannot be ignored if their impact can be large.

[edit] 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.

[edit] 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.

[edit] References

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

[edit] See also

• Systemic risk
• Cost risk
• Credit risk
• Demand risk
• Legal risk
• Liquidity risk
• Operational risk
• Optimism bias
• Risk modeling
• Risk attitude

[edit] External links

• Managing market risks by forward pricing
• How hedge funds limit exposure to market risk