Market Risk - Definition, What is Market Risk, Advantages of Market Risk, and Latest News - ClearTax (2024)

Introduction

Market risk is a measure of all the factors affecting the performance of financial markets. From an investor’s perspective, it refers to the possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets in which such investor has made investments.

Market risk is characterised by "systematic risk". The same cannot be eliminated through diversification, though it can be hedged against in many ways.

Understanding Market Risk

There are various sources for market risk which include macro factors such as changes in interest rates, foreign trade policy, industrial output indicators, political turmoil, natural disasters and terrorist attacks. Systematic, or market risk tends to influence broad market behaviour.

Systematic risk can be differentiated from unsystematic risk, which is unique to a specific sector or industry or company. In the context of investment folio, it is called as non-systematic risk, specific risk, diversifiable risk or residual risk. An investor can reduce The unsystematic risk in an investment portfolio can be reduced through diversification.

The investment risk comprises of two major components namely market (systematic) risk and specific risk (unsystematic). The general types of market risks include interest rate risk, equity risk, debt risk, foreign exchange risk, currency risk and commodity risk.

The market regulators such as the Securities and Exchange Commission (SEC) or Securities and Exchange Board of India (SEBI) mandate disclosures by public corporations. Publicly-traded companies in the United States must disclose the effects of their productivity and results on the performance of the financial markets to the SEC. The requirement seeks to obtain the details of a company's exposure to financial risk.

For example, an investment company engaged in providing derivative products or foreign exchange futures are exposed to financial risk in comparison with companies that provide other types of investments. Such information helps investors and traders make better decisions based on their own risk assessment and risk management rules.