The return on any asset is determined by the expectation of future discount rate fluctuations. If interest rates are expected to fall, short-term investments will be less attractive while long-term investments will get more attractive. Longer-term bonds will continue to…

The market value of any asset is the sum of the present value of cash flows expected to be generated by the asset. Several factors determine the expected values of these cash flows. Some of these factors include the discount…

Capital allocation is critical to a firm’s market risk management. It involves setting limits on all activities and giving priority, in resource allocation, to areas expecting the greatest reward. When wisely allocating capital, a company ensures that all its risk…

Effective management of risk is highly dependent on designing suitable constraints that can be used in market risk management. Measuring VaR to a confidence level as high as 99% and placing a loose limit can be less of a constraint…

Risk measures differ among market participants mainly because of the following factors: The degree to which a participant is leveraged and their need to assess minimum capitalization or maximum leverage ratios. Risks to which different businesses are exposed. The regulatory…

The following are some of the advantages and limitations of sensitivity and scenario analysis methods of measuring risk: Advantages of Sensitivity Risk Measures In-depth analysis of dependence: Sensitivity analysis ensures an in-depth study of the independent variables (risk factors) and…

Sensitivity Risk Measures Remember that sensitivity risk measures include beta, duration, convexity, and the option Greeks. Beta measures the sensitivity of an equity’s expected return to the equity risk premium. Duration is perhaps the most important risk measure in fixed-income…

Equity Exposure Measures Alpha: This is a financial risk ratio used in the prediction of returns obtained from holding an investment. It measures the value created by an active fund manager or an index provider. Investors prefer a positive and…

Sensitivity Risk Measures Sensitivity analysis involves determining how changes in risk factors affect the value of an asset or a portfolio. This process measures the sensitivity of the value of the assets to one or more risk factors. Sensitivity analysis…

Conditional Value at Risk (CVaR) Rockafellar and Uryasev introduced conditional value-at-risk (CVaR) in 2000. CVaR is a tail risk metric that quantifies the amount of the expected losses beyond the VaR cutoff point at a specific confidence level. It is…