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Market risk is the risk that the value of an investment will decrease due to moves in market
factors.

 Volatility frequently refers to the standard deviation of the change in value of a financial
instrument with a specific time horizon. It is often used to quantify the risk of the instrument
over that time period. Volatility is typically expressed in annualized terms, and it may either be
an absolute number ($5) or a fraction of the initial value (5%).


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Ôhe four standard market risk factors include:


M ½quity risk, or the risk that stock prices will change.


M Interest rate risk, or the risk that interest rates will change.


M 0urrency risk, or the risk that foreign exchange rates will change.

M 0ommodity risk, or the risk that commodity prices (i.e. grains, metals, etc.) will change.

Sometimes, a fifth risk factors is also considered:

½quity index risk, or the risk that stock or other index prices will change adversely.


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Market risk is typically measured using a Value at Risk methodology. Value at risk is well
established as a risk management technique, but it contains a number of limiting assumptions
that constrain its accuracy. Ôhe first assumption is that the composition of the portfolio measured
remains unchanged over the single period of the model. For short time horizons, this limiting
assumption is often regarded as acceptable. For longer time horizons, many of the transactions in
the portfolio may mature during the modeling period. Intervening cash flow, embedded options,

changes in floating rate interest rates, and so on are ignored in this single period modeling
technique.

Market risk can also be contrasted with Specific risk, which measures the risk of a decrease in
ones investment due to a change in a specific industry or sector, as opposed to a market-wide
move.


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M Ñeta
M iversification 
M Systematic Risk 
 M ènsystematic Risk 
M ½quity Risk
M 0urrency Risk 
M ÿortfolio Ôheory 
 M ÿortfolio Insurance 
M 0redit Risk 
M 0ommodity Risk
M egal Risk
M iquidity Risk 
M -perational Risk 
M Volatility 

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[edge fund managers argue that performance fees help to align the interests of manager and
investor better than flat fees that are payable even when performance is poor. [owever,
performance fees have been criticized by many people including notable investor Warren Ñuffett

for giving managers an incentive to take risk, possibly excessive risk, as opposed to high long-
term returns. In an attempt to control these problems, fees are usually limited by high water
marks and sometimes by hurdle rates.


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In the ènited States, a section on market risk is mandated by the S½0 in all annual reports
submitted on Form 10-K. Ôhe company must detail how its own results may depend directly on
 financial markets. Ôhis is designed to show, for example, an investor who believes he is investing
in a normal milk company, that the company is in fact also carrying out non-dairy activities such
as investing in complex derivatives or foreign exchange futures.