Chapter 5: Market Risk Flashcards
What is market risk?
The risk of loss arising from changes in the value of financial instruments
What is a direct market risk factor?
Direct company performance. E.G. Balance Sheet, Earnings, Management.
What is an indirect market risk factor?
Variables outside the company’s control. Interest rates, economic environment, sector sentiment.
What is volatility risk?
The risk that price movements are more uncertain than usual.
What is market liquidity risk?
Not being able to trade at a desired price due to a lack of market participants.
What is currency risk?
Caused by adverse movements in exchange rates. Occurs when an investor holds an instrument in a currency different from their base currency.
What is basis risk?
When one risk exposure is hedged in another instrument that behaves in a manner that may not be completely opposite. Basis risk exists to the extent that the two positions do not exactly mirror each other.
What is interest rate risk?
Caused by adverse movements in central interest rates.
What is Equity risk?
Capital growth or income is lower than expected.
Why are interest rates and bond prices inversely related?
Higher interest rates make the return provided by bonds less appealing. In order for it to become attractive to investors the price has to fall.
What is hedging?
Reducing the risk of adverse price movements by taking an offsetting position in a related product. Insurance against market risk.
What products are commonly used to hedge?
Derivatives, primarily futures, and options.
What are market risk limits?
Tools for managing market risk. E.g. Maximum loss
What are the problems with market risk limits?
They often have to be inflated to accommodate uncertainty in risk measurement.
How does diversifying lower risk?
A portfolio will have a lower standard deviation of return than an individual security
What is the aim of market risk analysis?
Not to eliminate risk, but to be able to predict which market risks yield the greatest returns.
What is the issue with large data sets for market risk analysis?
Hard to distinguish between expected behaviours and outliers
What is the central tendency in a sample?
A single number that captures the ‘essence’ of the distribution
What is dispersion in a sample?
How far the other values stray from the central tendency
How can central tendency be measured? 3 ways.
Mean, mode, median
What is the difference between quantitative and qualitative data?
Quantitative is countable/measurable. Qualitative is descriptive.
How is dispersion measured? 4 ways
Range
Quartile deviation
Variance
Standard Deviation
What is Quartile Deviation?
It is the measure of the dispersion through the middle half of a distribution.
How do you calculate Quartile Deviation?
Step one
* Find the median of the data set and call this median Q2 (Q2 is also called the second quartile value).
Step two
* Use Q2 to divide the original data set into two parts.
* The lower 50% consists of those values less than Q2.
* The upper 50% consists of values greater than Q2.
If the number of items in the dataset is odd, then include Q2 in both the lower and upper data sets.
Step three
* Calculate Q1 as the median of the lower data set (Q1 is called the first quartile position).
* Calculate Q3 as the median of the upper data set (Q3 is called the third quartile position).
Step four
* (Q3 – Q1)/2 is the quartile deviation.
