Market risk: concept, forms, risk management

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:40

The assertion that any economic activity involves risk does not raise any doubts among entrepreneurs.

When engaged in production, trade or provision of services, the leaders of companies and firms are guided by a market system that dictates peculiar laws, rules, the concept of norms and competition. It is simply impossible to calculate the functioning of economic systems with complete certainty and certainty.

The importance of good risk management

The process of making managerial decisions of various scales (from everyday local importance to strategic and vital ones for the organization) is influenced by a large number of different factors and conditions. Uncertainty, which is expressed in a lack of information, data, as well as in the influence of a random factor, prevents one or another outcome of a situation from being predicted for sure.

Risk is becoming a kind of economic uncertainty. This phenomenon is inherent in most areas of human activity. Today, employees who know how to research,predict and analyze risks are considered extremely important for the successful functioning of the enterprise. The amount of profit, competitiveness and the very survival of a firm largely depend on the ability of its managers to predict the consequences of a given action.

Analyze market financial risks entrusted to specialists who have sufficient experience and qualifications. The task of such a manager is to ensure the protection of the assets and profits of the company from losses incurred as a result of changes and fluctuations in interest rates, exchange rates and other economic and financial phenomena.

What is risk: concept, characteristics

Risk is a situation associated with the existence of a certain choice between several proposed alternatives. The occurrence of a risky event entails both a positive and a negative result.

In other words, risk is the possibility of success or failure. This concept should be distinguished from uncertainty, since risk can be estimated and its impact can be measured.

Signs of a risk situation:

• There is uncertainty.
• It is possible to choose an alternative course of action (one of them is to refuse a choice).
• Existing alternatives can be assessed.

The most important property of risk, which allows the manager to take timely action to reduce the negative impact of individual factors, isprobability. This term means a mathematical assessment of the current situation. Probability reflects the calculation of the frequency of occurrence of a particular result. Such an assessment can only be carried out if there is sufficient statistical information (data, indicators, expert assessments and forecasts).

Market risk: features, types and specifics

The situation in which the characteristics of the economic condition of any object due to the action of market factors may not meet the expectations of decision makers - this is what constitutes market risk.

From other types of banking risk, such situations differ in that they are directly affected by market conditions. The types of market risk include interest rate risk, as well as stock and currency risks.

Risk for different types of organizations

The impact of risky situations on the activities of any enterprise is enormous, so ignoring them or insufficiently thorough research can lead to losses and even the collapse of the company. Market risk is a characteristic of the most important economic markets for which changes in interest rates are of great importance. This is the market for debt securities, stocks, currencies, commodities.

This category of risks reflects the possibility of losses (losses of finance) of credit institutions due to the fact that the price of financial instruments on the market has changed or exchange rates fluctuate. Also, this category of risk reflects the possibility of profit or loss of the trading organization in the event of price changes.

For banks, interest rate risk becomes the mostsignificant, as it directly affects the final result of the activity. It is expressed in the possibility of increasing or decreasing the value of the assets of a banking organization due to fluctuations in interest rates on deposits and loans.

Value of risk for investors

When evaluating the economic efficiency of future investments, each investor is interested in obtaining objective and reliable data on the degree of risk of a particular project.

He has a certain expected range of portfolio returns, and the possibility that the actual profit will go beyond this interval, and there is a market risk.

That is, it is the existence of the probability of receiving a loss, loss or shortfall in profit. Losses associated with the implementation of economic activities are material, labor and financial. Market financial risks have their own gradation, according to which the most highly profitable options for capital investments become, as a rule, extremely risky. Sometimes so much so that investors decide not to do business with them, as "the game is not worth the candle."

Why do risk situations occur?

Often external and internal causes are involved in the formation of risk situations.

Internal causes of market risk are:

1. Deliberate opposition. For example, the purchase or sale of a certain category of financial instruments.
2. Wrong things leaders do when makingmanagement decisions. This may be the acquisition or sale of shares, bonds, currencies, as well as errors in the number and timing of these manipulations.

External causes that form risky situations are considered to be:

1. Unfavorable change in the value of financial instruments due to events occurring with the issuer and general market conditions (affects equity risk).
2. Flying in precious metals.
3. Use a large number of specific financial instruments (bonds, loans, mortgages) that may not be repaid on time.
4. Sharply fluctuating exchange rates.
5. Cases when customers and contractors do not fulfill the terms of contracts.

What does "market risk assessment" mean?

In order to protect the enterprise from the unpredictable impact of risky situations, the market risk is subject to assessment and analysis.

The main goal of these actions is to keep the risk taken by the company within the limits that are taken into account when setting strategic goals. This is necessary to preserve assets and capital, and to reduce or eliminate losses.

Analyze all types of risks that are important for the activities of the enterprise (foreign exchange, commodity risk and others).

Steps of market risk management

After defining the goal, principles and methods of risk management, specialists proceed to the following actions:

• Revealmarket risk.
• Assess the degree of its influence and the level of probability.
• Observe market risk.
• Taking action to control and minimize risk.

The main problem of specialists involved in risk assessment and management is the lack of any universal recipes. Each situation and issue is unique and requires an individual approach. Therefore, along with qualifications, experience and professionalism, managers need such qualities as intuition and flexibility of thinking.