Library/CFA (Chartered Financial Analyst)/Portfolio Management — CFA Program Curriculum, 2026 • Level I • Volume 9/Glossary

Glossary

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Definitions of Risk Types and Drivers5 min

This glossary defines principal terms used in risk management and explains their relationships. Financial risk categories include market risk (price and rate movements), credit risk (counterparty default), and liquidity risk (difficulty selling assets without excessive price concession). Non-financial risks include operational risk (failures in people, systems, internal processes, or external events), legal and regulatory risk, accounting and tax risk, model risk (errors from wrong or misused models), tail risk (excess extreme outcomes beyond model assumptions), solvency risk (running out of cash), mortality and longevity risk (dying young or outliving financial resources), and property and casualty risk. Key risk drivers are global and domestic macroeconomic conditions, industry forces, and company-specific factors. Common quantitative risk metrics include probability, standard deviation (volatility), beta (sensitivity to the market), duration (interest-rate sensitivity for fixed income), and derivatives Greeks: delta (first-order sensitivity to underlying), gamma (second-order sensitivity), vega (sensitivity to volatility), and rho (sensitivity to interest rates).

Key Points

Financial risks: market, credit, liquidity.
Non-financial risks include operational, legal, model, tail, solvency, mortality/longevity.
Risk drivers: macroeconomy, industry, company-specific factors.
Core metrics: probability, standard deviation, beta, duration, delta/gamma/vega/rho.

Tail Risk, VaR, CVaR, and Extreme Outcomes5 min

Value at risk (VaR) is a tail-size metric described by an amount, a time period, and a probability and represents a minimum extreme loss; conditional VaR (CVaR) is the weighted average of losses that exceed VaR. Stress testing and scenario analysis supplement VaR to evaluate extreme outcomes. Credit risk metrics include probability of default, expected loss given default, credit VaR, and credit spreads or CDS prices that imply default cost. Insurance is risk transfer by pooling diversified risks; deductibles, reinsurance, catastrophe bonds, surety and fidelity bonds are variations.

Key Points

VaR specifies currency amount, horizon, and probability and is a minimum-loss tail metric.
CVaR measures average loss beyond the VaR threshold.
Scenario analysis and stress tests model extreme events.
Insurers pool diversifiable risks; reinsurance and catastrophe bonds shift insurer risk.

Derivatives, Risk Shifting, and Insurance Mechanisms5 min

Risk shifting is typically performed with derivatives (forwards, futures, swaps, options) that change the distribution of outcomes; forwards lock in future prices with no up-front payment, while options provide rights for a premium. Risk modification alternatives are avoidance, prevention, acceptance (self-insurance and diversification), transfer (insurance), and shifting (derivatives). Deductibles encourage loss control and reduce small claims. Surety and fidelity bonds are narrow forms of insurance against nonperformance or employee dishonesty. Risk transfer requires weighing premiums and pooling suitability.

Key Points

Forwards/futures/swaps are forward commitments; options are contingent claims.
Options cost an up-front premium; forwards typically require no up-front cash.
Deductibles mix self-insurance with transfer and incentivize loss prevention.
Choice among methods depends on cost-benefit and alignment with risk tolerance.

Risk Interactions, Governance, and Measurement Limits5 min

Risk interactions (for example wrong-way risk, where credit risk increases when market exposure rises) often produce nonlinear effects that make combined exposures worse than the sum of parts; systemic risk arises when failures propagate across institutions and markets. Governance concepts include setting risk tolerance, allocating risk via risk budgeting, maintaining a risk infrastructure (people, systems, analytics), and using committees and chief risk officers to align risk exposures with enterprise objectives. Measurement limitations arise from rare events, model risk, and the difficulty of predicting regulatory, legal or accounting changes. Good practice emphasizes measuring, monitoring, and choosing appropriate mitigation methods by weighing costs versus benefits and ensuring alignment with the enterprise risk appetite.

Key Points

Risk interactions are common and typically non-linear (combined risk > sum of parts).
Wrong-way risk and systemic risk amplify losses in crises.
Risk governance: set tolerance, budget risk, build infrastructure, and report risks.
Measurement has limits: rare events, model risk, and uncertain regulatory changes.

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Question 1

Which definition best describes market risk?

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