RiskMetrics - Market Risk
Identify market risk and its four components
Observed every minute of each trading day, market risk is well known by all investors. Market risk arises from the fluctuating prices of investments as they are traded in the global markets. Market risk changes cyclically, from calm times to periods with wild price swings. RiskGrades were conceived to help investors measure their continually changing exposure to market risk.
Components of market risk
For example, the table below shows the risks associated with each investment, from the perspective of a U.S. investor:
|Investments||Equity Risk||Interest Rate Risk||Currency Risk||Commodity Risk|
|Bangkok Bank stock|
|5yr GE bond 8.25%|
|5yr US T-Note|
The market risk examples above are straightforward: owning stocks (IBM) exposes you to equity risk, owning bonds (GE bond and US T-Note) exposes you to interest rate risk, and owning commodities (gold) exposes you to commodity risk.
In some cases, however, an investment can be exposed to more than one component of market risk, simultaneously. For example, a U.S. investor who owns shares of a foreign stock like Bangkok Bank will be exposed to both equity and currency risk (i.e., potential loss arising from depreciation of Thai baht relative to US dollar).
RiskGrades measure total market risk, which often includes the effect of multiple subcomponents (i.e., currency plus equity risk as in the Bangkok Bank example).