A financial market is a market where people trade financial products. Typical financial markets are the fixed income and interest rate market, the currency market, the equity market, the commodity market and the credit market.

Financial business is exposed to many types of risks due to the nature of business. To guard against the risk, financial institutions must hold capital in proportion to the potential risk. Market risk economic capital is intended to capture the value change due to changes in market risk factors. It is an internal capital reserve to cover unexpected loss due to market movement.

Value at Risk (VaR) is the regulatory measurement for assessing market risk. It reports the maximum likely loss on a portfolio for a given probability defined as x% confidence level over N days. VaR is vital in market risk management and control. Also regulatory and economic capital computation is based on VaR results. Although VaR measure is objective and intuitive, it doesn’t capture tail risk. There are three commonly used methodologies to calculate VaR – parametric, historical simulation and Monte Carlo simulation. This presentation focuses on parametric VaR.

Risk sensitivities, also referred to as Greeks, are the measure of a financial instrument’s value reaction to changes in underlying factors. The value of a financial instrument is impacted by many factors, such as interest rate, stock price, implied volatility, time, etc. Sensitivities are risk measures that are more important than fair values.