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Market risk


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Market risk

  1. 1. arket risk is the risk that the value of a portfolio, either an investment portfolio or atrading portfolio, will decrease due to the change in value of the market risk factors. Thefour standard market risk factors are stock prices, interest rates, foreign exchange rates,and commodity prices. The associated market risks are: Equity risk, the risk that stock or stock indexes (e.g. Euro Stoxx 50, etc. ) prices and/or their implied volatility will change. Interest rate risk, the risk that interest rates (e.g. Libor, Euribor, inflation, etc.) and/or their implied volatility will change. Currency risk, the risk that foreign exchange rates (e.g. EUR/USD, EUR/GBP, etc.) and/or their implied volatility will change. Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil, etc.) and/or their implied volatility will change.[edit]Measuring the potential loss amount due to market riskAs with other forms of risk, the potential loss amount due to market risk may bemeasured in a number of ways or conventions. Traditionally, one convention is touseValue at Risk. The conventions of using Value at risk is well established andaccepted in the short-term risk management practice.However, it contains a number of limiting assumptions that constrain its accuracy. Thefirst assumption is that the composition of the portfolio measured remains unchangedover the specified period. Over short time horizons, this limiting assumption is oftenregarded as reasonable. However, over longer time horizons, many of the positions inthe portfolio may have been changed. The Value at Risk of the unchanged portfolio isno longer relevant.The Variance Covariance and Historical Simulation approach to calculating Value atRisk also assumes that historical correlations are stable and will not change in thefuture or breakdown under times of market stress.In addition, care has to be taken regarding the intervening cash flow, embeddedoptions, changes in floating rate interest rates of the financial positions in the portfolio.They cannot be ignored if their impact can be large.
  2. 2. Default (finance)From Wikipedia, the free encyclopedia Finance Financial markets[show] Financial instruments[show] Corporate finance[show] Personal finance[show] Public finance[show] Banks and banking[show] Financial regulation[show] Standards[show] Economic history[show]  V  T  EIn finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract,e.g. has not made a scheduled payment, or has violated a loan covenant (condition) of the debt contract. Adefault is the failure to pay back a loan.[1] Default may occur if the debtor is either unwilling or unable to paytheir debt. This can occur with all debt obligations including bonds, mortgages, loans, and promissory notes. Contents
  3. 3. [hide]1 Distinction from insolvency and bankruptcy2 Types of default o 2.1 Sovereign defaults o 2.2 Orderly defaults o 2.3 Strategic default o 2.4 Sovereign strategic default3 Consumer default4 See also5 References6 Bibliography[edit]Distinction from insolvency and bankruptcyThe term default should be distinguished from the terms insolvency and bankruptcy. "Default" essentially means a debtor has not paid a debt which he or she is required to have paid. "Insolvency" is a legal term meaning that a debtor is unable to pay his or her debts. "Bankruptcy" is a legal finding that imposes court supervision over the financial affairs of those who are insolvent or in default.[edit]Types of defaultDefault can be of two types: debt services default and technical default. Debt service default occurs when theborrower has not made a scheduled payment of interest or principal. Technical default occurs when anaffirmative or a negative covenant is violated.Affirmative covenants are clauses in debt contracts that require firms to maintain certain levels of capitalor financial ratios. The most commonly violated restrictions in affirmative covenants are tangible networth, working capital/short term liquidity, and debt service coverage.Negative covenants are clauses in debt contracts that limit or prohibit corporate actions (e.g. sale of assets,payment of dividends) that could impair the position of creditors. Negative covenants may be continuous orincurrence-based. Violations of negative covenants are rare compared to violations of affirmative covenants.With most debt (including corporate debt, mortgages and bank loans) a covenant is included in the debtcontract which states that the total amount owed becomes immediately payable on the first instance of a
  4. 4. default of payment. Generally, if the debtor defaults on any debt to the lender, a cross default covenant in thedebt contract states that that particular debt is also in default.In corporate finance, upon an uncured default, the holders of the debt will usually initiate proceedings (file apetition of involuntary bankruptcy) to foreclose on any collateral securing the debt. Even if the debt is notsecured by collateral, debt holders may still sue for bankruptcy, to ensure that the corporations assets areused to repay the debt.There are several financial models for analyzing default risk, such as the Jarrow-Turnbull model, EdwardAltmans Z-score model, or the structural model of default by Robert C. Merton (Merton Model).[edit]Sovereign defaultsMain article: Sovereign defaultSovereign borrowers such as nation-states generally are not subject to bankruptcy courts in their ownjurisdiction, and thus may be able to default without legal consequences. One example is withNorth Korea,which in 1987 defaulted on some of its loans. In such cases, the defaulting country and the creditor are morelikely to renegotiate the interest rate, length of the loan, or the principalpayments.[2] In the 1998 Russianfinancial crisis, Russia defaulted on its internal debt (GKOs), but did not default on its external Eurobonds. Aspart of the Argentine economic crisis in 2002, Argentinadefaulted on $1 billion of debt owed to the WorldBank.[3][edit]Orderly defaultsIn times of acute insolvency crises, it can be advisable for regulators and lenders to preemptively engineer themethodic restructuring of a nations public debt- also called "orderly default" or "controlled default".[4][5] Expertswho favor this approach to solve a national debt crisis typically argue that a delay in organising an orderlydefault would wind up hurting lenders and neighboring countries even more.[6][edit]Strategic defaultMain article: Strategic defaultWhen a debtor chooses to default on a loan, despite being able to service it (make payments), this is said to bea strategic default. This is most commonly done for non-recourse loans, where the creditor cannot make otherclaims on the debtor; a common example is a situation of negative equity on a mortgage loan in commonlaw jurisdictions such as the United States, which is in general non-recourse. In this latter case, default iscolloquially called "jingle mail" – the debtor stops making payments and mails the keys to the creditor, generallya bank.
  5. 5. [edit]Sovereign strategic defaultAs with Strategic default when a debtor chooses to default on a loan sovereign borrowers such as nation-states also can choose to default on a loan. Ecuadors president Rafael Correa in 2008 had given the order notto approve a debt interest payment.[7] See also Odious debt.[edit]Consumer defaultConsumer default frequently concern arrears in rent or mortgage payments, consumer credit, or utilitypayments. A European Union wide analysis identified certain risk groups, such as single households, beingunemployed – even after correcting for the (significant) impact of having a low income -, being young(especially being younger than around 50 years old, with somewhat different results for the New MemberStates, where the elderly more often at risk as well), being unable to rely on social networks, etc. Even internetilliteracy has been associated with increased default, potentially caused by these households being less likelyto find their way to the social benefits they are often entitled to. While effective non-legal debt counseling isusually the preferred -more economic and less disruptive- option, consumer default can end-up in legal debtsettlement or consumer bankruptcy procedures, the last ranging from 1-year procedures in the UK to 6-yearprocedures in Germany.[8]