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Market Risk
see also: value-at-risk
                 

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  1. Definition
  2. Examples, Types, or Variations
  3. Formula
  4. Related Terms
  5. As Used in the Hedge Fund World
  6. Applications
  7. Misused & Abused
  8. Additional Sources of Information
    1. Books
    2. News
    3. Scholarly Papers
       
 

1.
 

Definition
 
 

Market risk is the risk that the value of an investment will decrease due to moves in market factors.

Volatility frequently refers to the standard deviation of the change in value of a financial instrument with a specific time horizon. It is often used to quantify the risk of the instrument over that time period. Volatility is typically expressed in annualized terms, and it may either be an absolute number ($5) or a fraction of the initial value (5%).

Other Resources:

  • Commerce Capital Markets: The chance that a security's value will decline. With fixed income securities, market risk is closely tied to interest rate risk--as interest rates rise, prices decline and vice versa. More…
     
  • Key.com: Also called systematic risk. The portion of a security's risk common to all securities in the same asset class, and that cannot be eliminated through diversification. More…
     
  • Stanlake Search: The sensitivity of the market value of a portfolio to changes in financial asset prices such as: interest rates, foreign exchange rates, equity prices, and commodity prices. More…
     
  • HSBC: The risk to stocks, bonds and other financial instruments resulting from a decline in the market. More…
     
  • Reliance Mutual Fund: The risk that the price of a security will rise or fall due to changing economic, political, or market conditions, or due to a company's individual situation. More…
     

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2.
 

Examples, Types, or Variations
 
 

The four standard market risk factors include:
 

Sometimes, a fifth risk factors is also considered:

Equity index risk, or the risk that stock or other index prices will change adversely.


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3.
 

Formula
 
  Market risk is typically measured using a Value at Risk methodology. Value at risk is well established as a risk management technique, but it contains a number of limiting assumptions that constrain its accuracy. The first assumption is that the composition of the portfolio measured remains unchanged over the single period of the model. For short time horizons, this limiting assumption is often regarded as acceptable. For longer time horizons, many of the transactions in the portfolio may mature during the modeling period. Intervening cash flow, embedded options, changes in floating rate interest rates, and so on are ignored in this single period modeling technique.

Market risk can also be contrasted with Specific risk, which measures the risk of a decrease in ones investment due to a change in a specific industry or sector, as opposed to a market-wide move.

 

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4.
 

Related Terms
 
 
  • Beta
  • Diversification
  • Systematic Risk
  • Unsystematic Risk
  • Equity Risk
  • Currency Risk
  • Portfolio Theory
  • Portfolio Insurance
  • Credit Risk
  • Commodity Risk
  • Legal Risk
  • Liquidity Risk
  • Operational Risk
  • Volatility
     

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5.
 

As Used in the Hedge Fund World
 
 

Hedge fund managers argue that performance fees help to align the interests of manager and investor better than flat fees that are payable even when performance is poor. However, performance fees have been criticized by many people including notable investor Warren Buffett for giving managers an incentive to take risk, possibly excessive risk, as opposed to high long-term returns. In an attempt to control these problems, fees are usually limited by high water marks and sometimes by hurdle rates.

Other Resources:

  • Financial Engineering Associates: Recent experience has clearly shown that measurement and management of extreme event and tail risk is paramount for hedge funds. Traditional market risk management applications rely on risk estimation methodologies only suitable for normal market conditions, and risk managers play a limited role in the risk measurement process. More…
     

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6.
 

Applications
 
  In the United States, a section on market risk is mandated by the SEC in all annual reports submitted on Form 10-K. The company must detail how its own results may depend directly on financial markets. This is designed to show, for example, an investor who believes he is investing in a normal milk company, that the company is in fact also carrying out non-dairy activities such as investing in complex derivatives or foreign exchange futures.
 

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7.

 

Misused & Abused
see: due diligence
 
 



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8.
 

Additional Sources of Information
 
 
  1. Books
  2. News
  3. Scholarly Papers

 

Back to Terms

News Books Scholarly Definitions

HEDGE FUND RISK AND OTHER DISCLOSURES
Hedge funds, including fund of funds (“Hedge Funds”), are unregistered private investment partnerships, funds or pools that may invest and trade in many different markets, strategies and instruments (including securities, non-securities and derivatives) and are NOT subject to the same regulatory requirements as mutual funds, including mutual fund requirements to provide certain periodic and standardized pricing and valuation information to investors. There are substantial risks in investing in Hedge Funds. Persons interested in investing in Hedge Funds should carefully note the following:
  • Hedge Funds represent speculative investments and involve a high degree of risk. An investor could lose all or a substantial portion of his/her investment. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment in a Hedge Fund.
  • An investment in a Hedge Fund should be discretionary capital set aside strictly for speculative purposes.
  • An investment in a Hedge Fund is not suitable or desirable for all investors. Only qualified eligible investors may invest in Hedge Funds.
  • Hedge Fund offering documents are not reviewed or approved by federal or state regulators
  • Hedge Funds may be leveraged (including highly leveraged) and a Hedge Fund’s performance may be volatile
  • An investment in a Hedge Fund may be illiquid and there may be significant restrictions on transferring interests in a Hedge Fund. There is no secondary market for an investor’s investment in a Hedge Fund and none is expected to develop.
  • A Hedge Fund may have little or no operating history or performance and may use hypothetical or pro forma performance which may not reflect actual trading done by the manager or advisor and should be reviewed carefully. Investors should not place undue reliance on hypothetical or pro forma performance.
  • A Hedge Fund’s manager or advisor has total trading authority over the Hedge Fund.
  • A Hedge Fund may use a single advisor or employ a single strategy, which could mean a lack of diversification and higher risk.
  • A Hedge Fund (for example, a fund of funds) and its managers or advisors may rely on the trading expertise and experience of third-party managers or advisors, the identity of which may not be disclosed to investors
  • A Hedge Fund may involve a complex tax structure, which should be reviewed carefully.
  • A Hedge Fund may involve structures or strategies that may cause delays in important tax information being sent to investors.
  • A Hedge Fund may provide no transparency regarding its underlying investments (including sub-funds in a fund of funds structure) to investors. If this is the case, there will be no way for an investor to monitor the specific investments made by the Hedge Fund or, in a fund of funds structure, to know whether the sub-fund investments are consistent with the Hedge Fund’s investment strategy or risk levels.
  • A Hedge Fund may execute a substantial portion of trades on foreign exchanges or over-the-counter markets, which could mean higher risk.
  • A Hedge Fund’s fees and expenses-which may be substantial regardless of any positive return- will offset the Hedge Fund’s trading profits. In a fund of funds or similar structure, fees are generally charged at the fund as well as the sub-fund levels; therefore fees charged investors will be higher that those charged if the investor invested directly in the sub-fund(s).
  • Hedge Funds are not required to provide periodic pricing or valuation information to investors.
  • Hedge Funds and their managers/advisors may be subject to various conflicts of interest.
The above general summary is not a complete list of the risks and other important disclosures involved in investing in Hedge Funds and, with respect to any particular Hedge Fund, is subject to the more complete and specific disclosures contained in such Hedge Fund’s respective offering documents. Before making any investment, an investor should thoroughly review a Hedge Fund’s offering documents with the investor’s financial, legal and tax advisor to determine whether an investment in the Hedge Fund is suitable for the investor in light of the investor’s investment objectives, financial circumstances and tax situation.

All performance information is believed to be net of applicable fees unless otherwise specifically noted. No representation is made that any fund will or is likely to achieve its objectives or that any investor will or is likely to achieve results comparable to those shown or will make any profit at all or will be able to avoid incurring substantial losses. Past performance is not necessarily indicative, and is no guarantee, of future results.

The information on the Site is intended for informational, educational and research purposes only. Nothing on this Site is intended to be, nor should it be construed or used as, financial, legal, tax or investment advice, be an opinion of the appropriateness or suitability of an investment, or intended to be an offer, or the solicitation of any offer, to buy or sell any security or an endorsement or inducement to invest with any fund or fund manager. No such offer or solicitation may be made prior to the delivery of appropriate offering documents to qualified investors. Before making any investment, you should thoroughly review the particular fund’s confidential offering documents with your financial, legal and tax advisor and conduct such due diligence as you (and they) deem appropriate. We do not provide investment advice and no information or material on the Site is to be relied upon for the purpose of making investment or other decisions. Accordingly, we assume no responsibility or liability for a ny investment decisions or advice, treatment, or services rendered by any investor or any person or entity mentioned, featured on or linked to the Site.

The information on this Site is as of the date(s) indicated, is not a complete description of any fund, and is subject to the more complete disclosures and terms and conditions contained in a particular fund's offering documents, which may be obtained directly from the fund. Certain of the information, including investment returns, valuations, fund targets and strategies, has been supplied by the funds or their agents, and other third parties, and although believed to be reliable, has not been independently verified and its completeness and accuracy cannot be guaranteed. No warranty, express or implied, representation or guarantee is made as to the accuracy, validity, timeliness, completeness or suitability of this information.

Any indices and other financial benchmarks shown are provided for illustrative purposes only, are unmanaged, reflect reinvestment of income and dividends and do not reflect the impact of advisory fees. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular hedge fund. For example, a hedge fund may typically hold substantially fewer securities than are contained in an index. Indices also may contain securities or types of securities that are not comparable to those traded by a hedge fund. Therefore, a hedge fund’s performance may differ substantially from the performance of an index. Because of these differences, indexes should not be relied upon as an accurate measure of comparison.




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