Part 2 - Market Risk

Question 1

What is market risk caused by?

Answer 1

Market changes

May negatively impact the firm’s position / portfolio e.g. interest rate, asset liquidity

Question 2

How is market risk controlled?

Answer 2

Tactically and strategically

Using metrics e.g. the ‘Greeks’ - measure asset sensitivity to market changes

Alpha - measure of risk

Beta - level of volatility of a share against the market as a whole

Question 3

Name different types of market risk (8)

Answer 3

Price level
Commodity
Basis (difference between spot price and the cash price)
Volatility
Liquidity
Currency 
Interest Rate
Systematic (whole market)

Question 4

How can systematic risk be reduced?

Answer 4

Can’t be - risk remains even if portfolio is diversified.

Because factors affect the WHOLE MARKET

Question 5

How can unsystematic risk be reduced?

Answer 5

By diversification

Question 6

How can market risk be mitigated?

Answer 6

• Understand the market
• Apply independence on pricing
• Mark to model if mark to market not available
• Hedging offsets/mitigates a risk in taking a position
• Ensure policy and procedures in place
• Use various instruments (e.g. insurance policies / swaps / options / derivatives)

Question 7

What is market risk?

Answer 7

Risk that the VALUE of a market position or investment portfolio will DECREASE due to the change in value of the market risk factors