Question

Please discuss the importance of market risk through concentrating on:

-How market risk arises and how it can threaten the solvency of FIs.

-How to measure market risk

(Minimum 300 word,please)

Answer 1

Market Risk

Also called systematic risk, market risk is the possibility of an investor to incur losses due to the factors that affect the overall performance of the financial markets in which he or she is involved. It has the potential to hamper the financial markets and even to cause recession. The assets affected includes the financial instruments like bonds, debentures, etc.

Importance of Market Risk

How Market risk arises :Market risk arises due to price fluctuations. It is caused due to the changes in demand and supply. In a bull market prices of investments moves upward for a period of time while the prices goes down in a bear market. These fluctuations, if not identified in time can lead to a loss to the investor.

Threat to Financial institutions :Market risk is a major threat to financial institutions as it can affect the solvency of the securities issued by them. Fluctuating markets can cause a decrease in the long term investments.

Measuring Market Risk

Analysts use Value at Risk method(VaR) to measure market risk. It is a Statistical risk management method. Beta is another risk metric.

Setting limits above the actual ratios is another method to mitigate risk.