Market risk is the risk of loss due to the factors that affect an entire market or asset class. Four primary sources of risk affect the overall market. These include interest rate risk, equity price risk, foreign exchange risk, and commodity risk.
Market risk is also known as undiversifiable or unsystematic risk because it affects all asset classes and is unpredictable. An investor can only mitigate this market risk by hedging a portfolio. Risk can also be categorized as specific—systematic—risk and is limited to an industry or a single company.
Interest rate risk is the risk of increased volatility due to a change in interest rates. There are different types of risk exposures that can arise when there is a change in interest rates, such as basis risk, options risk, term structure risk, and repricing risk.
Basis risk is a component due to possible changes in spreads when interest rates fluctuate. Basis risk arises when there are changes in the spread between different markets' interest rates.
Equity Price Risk
Equity price risk is the risk that arises from security price volatility – the risk of a decline in the value of a security or a portfolio. Equity price risk can be either systematic or unsystematic risk. Unsystematic risk can be mitigated through diversification, whereas systematic cannot be. In a global economic crisis, equity price risk is systematic because it affects multiple asset classes.
A portfolio can only be hedged against this risk. For example, if an investor is invested in multiple assets that represent an index, the investor can hedge against equity price risk by buying put options in the index exchange-traded fund.
Foreign Exchange Risk
Currency risk, or foreign exchange risk, is a form of risk that arises when currency exchange rates are volatile. Global firms may be exposed to currency risk when conducting business due to imperfect hedges.
For example, suppose a U.S investor has investments in China. The realized return will be affected when exchanging the two currencies. Assume the investor has a realized 50% return on investment in China, but the Chinese yuan depreciates 20% against the U.S. dollar. Due to the change in currencies, the investor will only have a 30% return. This risk can be mitigated by hedging with currency exchange-traded funds.
Commodity Risk
Commodity price risk is the volatility in market price due to the price fluctuation of a commodity. Commodity risk affects various sectors of the market, such as airlines and casino gaming. A commodity's price is affected by politics, seasonal changes, technology, and current market conditions.
For example, suppose there is an oversupply of crude oil, which has caused oil prices to fall every day over the past six months. A company that is heavily invested in oil drilling wells faces commodity price risk. The company's profit margin will fall as well since it is still operating at the same cost, but the prices of crude oil are falling. Its profits will decrease. The company could use futures or options to hedge this risk and minimize the uncertainty of oil prices.
Four primary sources of risk affect the overall market. These include interest rate risk
interest rate risk
Interest rate risk is the potential that a change in overall interest rates will reduce the value of a bond or other fixed-rate investment: As interest rates rise bond prices fall, and vice versa. This means that the market price of existing bonds drops to offset the more attractive rates of new bond issues.
Exchange rate risk refers to the risk that a company's operations and profitability may be affected by changes in the exchange rates between currencies. Companies are exposed to three types of risk caused by currency volatility: transaction exposure, translation exposure, and economic or operating exposure.
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.
The most common types of market risks include interest rate risk, equity risk, currency risk, and commodity risk. Interest rate risk covers the volatility that may accompany interest rate fluctuations due to fundamental factors, such as central bank announcements related to changes in monetary policy.
The primary market is not immune to market risks. Factors such as economic downturns, industry-specific challenges, and geopolitical events can impact the performance of newly issued securities.
However, systematic risk incorporates interest rate changes, inflation, recessions, and wars, among other major changes. Shifts in these domains can affect the entire market and cannot be mitigated by changing positions within a portfolio of public equities.
Experts have been vetted by Chegg as specialists in this subject. QUESTION 28 The two primary components of a risk are: The probability and the impact.
The basic methods for risk management—avoidance, retention, sharing, transferring, and loss prevention and reduction—can apply to all facets of an individual's life and can pay off in the long run. Here's a look at these five methods and how they can apply to the management of health risks.
The OCC has defined nine categories of risk for bank supervision purposes. These risks are: Credit, Interest Rate, Liquidity, Price, Foreign Exchange, Transaction, Compliance, Strategic and Reputation. These categories are not mutually exclusive; any product or service may expose the bank to multiple risks.
The primary market is also known as new issues market, which refers to the market where securities, such as stocks, primary bonds, and debentures, are created and issued for the first time by companies or governments in order to raise capital.
The primary market is where securities are created. It's in this market that firms sell (float) new stocks and bonds to the public for the first time. An initial public offering, or IPO, is an example of a primary market.
Market risk is the risk of losses on financial investments caused by adverse price movements. Examples of market risk are: changes in equity prices or commodity prices, interest rate moves or foreign exchange fluctuations.
Marketing risk is the potential for failures or losses during any marketing activity, from production to promotion. Marketing risks could include any of the following examples: Pricing a product incorrectly. Choosing the wrong channel to advertise to a target audience.
Systematic risk is that part of the total risk that is caused by factors beyond the control of a specific company, such as economic, political, and social factors. It can be captured by the sensitivity of a security's return with respect to the overall market return.
The four popular types of market structures include perfect competition, oligopoly market, monopoly market, and monopolistic competition. Market structures show the relations between sellers and other sellers, sellers to buyers, or more.
As indicated above, the five types of risk are operational, financial, strategic, compliance, and reputational. Let's take a closer look at each type: Operational. The possibility that things might go wrong as the organization goes about its business.
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