The Nature Of Market Risk

Market risk is the risk of loss of position on and off-balance sheet due to market price movements.
Banks that have a position on the balance sheet financial instruments exposed to market risk
Banks that act as an intermediary in a transaction that is not posted on the bank's balance sheet is not exposed to market risk on these transactions

Market risk consists of:
Specific Risk → risk of price movements of securities due to factors relating to the securities or issuernya. Example: the price of a bond falls due from the issuer credit rating deteriorated → affect the bond of the issuer but does not affect the bonds in general.
General Market Risk → risk of market price movements of the entire instrument. Example: reduction in central bank interest rates caused a decrease in market interest rates, which will affect the value of all instruments related to interest rates.

General market risk is divided into 4 major categories for analysis purposes:
- Interest rate risk → potential losses due to changes in interest rates, calculated on all instruments that use one or more yield curves to calculate a market value.
- Equity position risk → potential losses due to changes in stock prices, which applied to all instruments that use stock as part of the assessment.
- Foreign exchange risk → potential losses due to exchange rate movements. This risk applies to all products and position in the exchange rate has a different value of the exchange rate used by banks in reporting.
- Commodity position risk → potential losses due to commodity price changes, apply to all commodities and derivatives.
All of the above risk categories do not stand alone because of changes in the value of a risk will affect the types of other market risks.

There are other types of market prices associated with derivatives trading, such as volatility rates, which have the same risk profile as the above categories.

The market price is influenced by several factors namely:
- Supply and demand of a product will affect the price level in the short term because the market makers adjust prices to take advantage.
- Liquidity can affect the market price
Liquid market → there are a lot of market makers and high-volume business → small profit → dealing costs for small traders.
Illiquid market → bigger profits and trade less actively
Liquid markets may become illiquid before the holiday or any announcement relating to the economy.
- Intervention by the monetary authorities can affect the market price for quick short-term.
- Arbitrage (where a market price set by one or more other market prices), will affect the daily price movements.
- Political and economic events along with natural disasters can affect the market price for a dramatic short-term (both locally and internationally).
- Underlying economic factors are the strongest drivers of long-term market prices.