This lesson explores the techniques used to measure and manage market risk, the risk of losses from adverse movements in market prices .

4.1 Market Risk Fundamentals
Market risk encompasses several sub-categories: interest rate risk, foreign exchange risk, equity price risk, and commodity price risk . Interest rate risk is a key focus, as net interest income makes up two-thirds of operating income for significant banks .

4.2 Value at Risk (VaR)
VaR is a standard measure for quantifying market risk . It estimates the maximum potential loss of a portfolio over a specific time horizon at a given confidence level . The University of Southampton module and NYIF course detail the calculation of VaR, including variance-covariance, historical simulation, and Monte Carlo approaches . VaR is also used to set risk limits for trading desks and to allocate capital .

4.3 Stress Testing and Scenario Analysis
While VaR provides a measure of normal market risk, stress testing and scenario analysis are used to evaluate a portfolio’s resilience under extreme but plausible market conditions . These tools are essential for understanding tail risks and for meeting regulatory expectations .