Foundations of Financial Risk: An Overview of Financial Risk and Risk-based Financial Regulation, 2nd Edition

CHAPTER 6 Market Risk

This chapter introduces market risk: the risk of losses on a bank's positions in financial assets or instruments due to adverse movements in market prices. Banks assume market risk because they trade as principals, risking their own capital, and hold positions in financial instruments. Failure to man­age market risk can have significant direct effects on a bank's profitability and reputation. After exploring the sources of market risk and the trading instruments banks use in their trading operations, this chapter covers various market risk measurement and management considerations, including the approaches outlined in the Market Risk Amendment to the Basel I Accord.

Chapter Outline

• 6.1 Introduction to Market Risk
• 6.2 Basics of Financial Instruments
• 6.3 Trading
• 6.4 Market Risk Measurement and Management
• 6.5 Market Risk Regulation

Key Learning Points

• Market risk arises from the trading activities of banks and is a consequence of movements in market prices.
• Market risk affects all financial instruments and can be general market risk, which reflects the market movements of all comparable financial instruments, or a specific risk, which reflects the risk that an individual financial instrument moves in day-to-day trading.
• The basic financial instruments are currencies, equities, bonds, loans, commodities, and derivatives. Banks can take either a long or a short position in financial instruments.
• The four different types of market risks are equity risk (equities), ...