A market risk analysis, if done effectively, can reveal investment risks.
A market risk analysis is the process of studying the risks facing an investor’s portfolio in an effort to mitigate those risks. Different risks are associated with different categories of securities, so it may be useful for investors to study these risks closely, assessing the likelihood that their portfolios will be exposed to specific threats and the severity of the impact if exposed. Furthermore, a market risk analysis must take into account the risks involved with the various sectors of the market. Another way to use this term is to describe the analysis that a company performs before entering a specific market for the first time.
Different risks are associated with different categories of securities.
When people think of investing, they generally think in terms of the positive benefits of investing; after all, the purpose of investing is to increase passive wealth. However, investing also carries the very real risk of losing a good deal of your principal. To minimize the risks associated with normal investing, investors may perform, or engage a financial services professional to perform, a market risk analysis.
There are many different ways to perform 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 done effectively, can reveal these risks. For example, stocks are risky because prices can plummet and thus devalue the stocks held by investors. By contrast, bond investors need to worry about the possibility that issuing institutions will default or raise interest prices. 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 if expanding into a new market is worth the risk. A company that is used to doing business in a specific area may not be aware of all the problems inherent in a new market. For this reason, a proper analysis can answer many pertinent questions and give company managers peace of mind.