Market Risk and Counterparty Credit Risk

Lourenco Miranda

In the previous chapter, we discussed operational risk and why it is one of the many types of risk for which the banks need to prepare. This chapter will focus on two more types of risk: market risk and counterparty credit risk.

MARKET RISK

Market risk is the risk that a position on a specific financial asset or a derivative of that asset, short or long, may change due to changes in market prices. The asset in question can be interest rate, commodity, foreign exchange, equity or credit. Financial institutions will estimate their market risk based upon, but not limited to, an assessment of the following valuation factors.

    • The sensitivity of the financial institution’s earnings or the economic value of its capital to adverse changes in interest rates, foreign exchanges rates, commodity prices or equity prices.
    • The ability of management to identify, measure, monitor and control exposure to market risk given the institution’s size, complexity and risk profile.
    • The nature and complexity of interest rate risk exposure arising from non-trading positions. Interest rate risk tends to affect the value of bonds more directly than stocks. The bondholder receives a fi

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