Market risk analysis assesses an investor’s portfolio to mitigate risks associated with different categories of securities and market sectors. Tools like stress tests and VaR calculations help analysts discover vulnerabilities and adjust portfolios accordingly. Companies can also use market risk analysis to determine the risks involved in expanding into new markets.
A market risk analysis is the process of studying the risks an investor’s portfolio faces in an effort to mitigate those risks. Different risks are associated with different categories of securities, so it can be useful for investors to study these closely, assessing the likelihood that their portfolios will be exposed to specific threats and the severity of the impact if they were exposed. Furthermore, a market risk analysis must take into account the risks involved in various market sectors. Another way this term is used is to describe the analysis a company performs before venturing into a specific market for the first time.
When people think of investing, they usually think in terms of the positive benefits of investing; after all, the purpose of investing is to grow passive wealth. Investing also carries the very real risk that a good deal of capital could be lost. To minimize the risks associated with normal investing, investors may undertake – or engage a financial services professional to perform – a market risk analysis.
There are many different ways to carry out a market risk analysis. Investment professionals often perform hypothetical stress tests to see how a portfolio would perform in a worst-case scenario. Another popular tool is the “Value at Risk” or VaR calculation, which uses past price performance and the inherent volatility of securities as a way to assess portfolio risk. These and many other tools allow analysts to discover where portfolios are vulnerable and how they can be adjusted to compensate.
Each different class of securities is associated with a specific set of risks and a market risk analysis, if carried out effectively, can uncover these risks. For example, stocks are risky because prices can plummet and thus devalue the stock held by investors. Bond investors, on the other hand, need to worry about institutions defaulting or rising interest rates. Whatever the security, a risk analyst can analyze the risks involved and find ways to alleviate them.
Companies can also take advantage of a different type of market risk analysis to find out whether expanding into a new market is worth the risk involved. A company that is used to doing business in a specific area may not be aware of all the problems associated with a new market. For this reason, a proper analysis can answer many pertinent questions and provide peace of mind for company managers.
Asset Smart.
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