Credit and Market Risks2/28/2010Student Aims and objectives of the paper Part 1 covers the developments in the credit and market risks. While doing so, the essay provides the measurement and management methods in relation to the current financial crisis. In the end, it summaries the available methods while giving their strengths, weaknesses. It also gives the mechanism of the implementation in effective risk management policy. Part 2 discusses the credit risk and thoroughly examines its management in the current financial markets based upon the modern methods of credit risk exposure, risk factors, its pricing and incorporation in the instruments and making the credit markets viable and feasible.
Part 1Discussion on the developments in the Market and Credit Risks Measurements and management in view of the Financial Crisis Generally, there are following types of risks in the financial markets. Market risks Credit risks Liquidity risks Operational risks Systematic risk Price or rates risks Credit quality volatility Unadjusted financial positions Fraud and systems failures, legal and regulatory risks Market ruptures breakdowns Risks in the financial markets are many and multiple. In the background of current world financial crunch and crumbling financial institutions in the United States of America and Middle East countries like Dubai, the markets and credit risks have become more prominent and imminent.
So, there is a need to understand the difference between the two terms and have an in-depth knowledge of their measurement and management. Market risk is the genre term of any sort of risk associated with the nature, quantum, working and outcomes of a market, whereas the credit risk refers to that signified element of risk which is hidden in a derivative transaction (Chand Sooran 2007).
The important methodological distinctions of liquidity and time horizons make the two things different from each other. If price volatility defines the market risk then default defines the credit risk. A market price risk is conceptually the negative daily profitability of a firm. The relative market prices of other firms and products are also included in the market price risks (Joetta 2005). The performance hedges automatically change negatively. On the other hand, credit risk directly involves the default or the short credit supply by the creditor to the counterparty.
The negative impact of the credit risk is the high price of credit for the other borrowers and volatility of credit from the market etc. The dealers in the financial markets are always very cautious about their dealings with their counterparts in their swap transactions. It simply means that greater charges are levied on the financial transactions by the dealers against their counterparties (Andrew Fight 2006). The greatest risk envisioned by the dealers can be the risk of default in repayment of installments by the counterparty.
The market fluctuations and untoward changes often put the portfolios of the counterparties at the default position. In this way the credit-worthiness of the counterparties also adversely suffers. The market and credit risks have become more obvious after the emergence of regulatory regimes like insurance companies etc. The common revaluation method is the market risk management system (Heath, Harrow, and Morton 1992). Available Methods, their strengths and weaknesses Option for large portfolios and loans positions can be obtained by the integrated pricing and management system.
The components of the market risks are developed. Risk factors driving portfolios returns are priced and managed. The market risks are visualized and calculated on the basis of abrupt price fluctuations in the markets. Delta gamma approach sees at the stochastic volatility of equilibrium in the markets. The tail losses of the portfolios are measured on the basis of their exposures in the markets (Tomlinson, Richard; Evans, David (2007).