Market, Liquidity, and Interest Rate Risk
Market risk
Market risk is loss from movements in prices, rates, and volatilities. It includes interest rate, equity, foreign exchange, commodity, and spread risk. Measures include sensitivity (duration, beta, Greeks), value at risk, expected shortfall, and stress testing. Directional and non-directional exposures must be distinguished, and hedging basis risk remains after hedging.
Liquidity risk
Liquidity risk has two forms: funding liquidity risk, the inability to meet obligations as they fall due, and market liquidity risk, the inability to trade without moving prices. Liquidity coverage and net stable funding ratios, cash-flow laddering, and concentration of funding sources are key concepts. A trap is assuming liquid assets remain liquid in stress; correlations and haircuts worsen together.
Interest rate risk in the banking book
Repricing gaps, duration, basis risk, and optionality (such as prepayment) drive earnings and economic value sensitivity. Parallel-shift assumptions miss curve and basis risk.
Worked rule of thumb
A bond position with duration of 5 loses roughly 5% of value for a 1% (100 basis point) rise in yields, using the linear approximation; convexity refines the estimate for larger moves. When a question asks which risk remains after a duration hedge, the answer is typically basis, curve, and convexity risk.