RiskMetrics - Market Risk


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

RiskGrades measure the four subcomponents of market risk: equity risk, interest rate risk, currency risk, and commodity risk. Each investment you make will face one or more of these component risks.

Example

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
IBM stock      
Bangkok Bank stock    
5yr GE bond 8.25%      
5yr US T-Note      
Gold (CMX)      

Foreign investments

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).


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