Chapter 16
Risk Management
Any number of risks can be associated with trading in the international securities markets and we have already covered many of them throughout the course of the book. In order to clarify one's thinking on the topic, a short taxonomy is provided below. Each individual risk is beyond the scope of this book; each could be the subject of an entire book. Given its topicality, Value at Risk (VaR) is examined because it is not widely understood and its use as a risk measurement has been blamed, in part, for the 2008 recession.
Credit risk is the risk that a counterparty will not settle a transaction. This can be the customer side of a transaction or the market side as a result of a market counterparty failing to settle a trade (settlement risk).
Market risk is the risk associated with an adverse movement in the price of the asset.
Legal risk is the risk associated with the inability to enforce a contract due to a documentation failure or due to conducting an unauthorized business that renders a lawful contract unenforceable.
Operational risk is the risk associated with a deficiency in internal procedures.
Custody risk is the risk associated with the insolvency of a custodian or cash or the occurrence of other circumstances preventing the custodian from delivering securities or cash on request.
Credit risk, of course, is mitigated in a variety of subtle and simple ways. Margin requirements, good-faith deposits, guarantees, indemnification rights, liens, and ...
