EARLY SIGNALS

Effective risk management starts with identification and understanding of the various types of risks. It involves the establishment of risk limits, monitoring mechanisms, and the adoption of risk mitigating and other prudent practices. 

To test whether a firm is facing market risk or not there are some signals which may be indicated that firm is facing the same risk. 

a) Applying Wrong Models: - It might be possible that the models used to assess the risk are not adequately tested and may not be in position to perceive a big or rare or unforeseen events contributing to huge loss. 

b) Weak Internal Control: - Company may not have adequate internal control due to which it may be more exposed to market as action of speculation by one may be unchecked. 

c) Speculative Aptitude: - Treasury departments in companies involved in non financial business are meant for hedging the risk. However, it might be possible that they may be instructed to generate revenue and becomes profit centre. 

d) Non – Core Business:- As mentioned above a company may be involved in non core business activities such as making large profit from the sale and purchase of foreign exchange, which may not be questioned by the management nor any limits were set for the person involved in treasury dealings. 

In such a situation, it might be possible that company may incur a huge loss on account of market risk. 

e) Inexperience:- In some cases, it has been observed that a company may have exposure to those instruments or financial products for which it has no or very little experience. This type of exposure is normally undertaken to earn huge profit in short span of time.

a) Sovereign Default: - Sovereign debt crisis is one of the major signal of market risk as it will urge the investors to shift to more secure financial instrument. Further, sovereign debt crisis also lead to loss of confidence in other type of financial instruments. 

b) Style Drift:- In come cases it has been observed that to cover the loss some manager may divert fund to more speculative transaction and thus pushing the company to severe market risk. 

c) Superstar:- Sometime one person may be titled as superstar to which even management may be reluctant to question about his/her actions because of their his/her perceived ability to generate huge profits. In such a situation, it might be possible that there may be huge or unanticipated losses because these so called superstars may cross their limits. 

d) Inadequate Supervision: - Inadequate supervision may be another strong signal that highlight the company’s exposure to market risk.