Morgan Stanley 2009 Annual Report Download - page 95

Market Risk.
Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, implied
volatilities (the price volatility of the underlying instrument imputed from option prices), correlations or other
market factors, such as market liquidity, will result in losses for a position or portfolio. Generally, the Company
incurs market risk as a result of trading and client facilitation activities, principally within the Institutional
Securities business where the substantial majority of the Company’s VaR for market risk exposures is generated.
In addition, the Company incurs trading-related market risk within the Global Wealth Management Group. Asset
Management incurs non-trading market risk primarily from capital investments in real estate funds and
investments in private equity vehicles.
Sound market risk management is an integral part of the Company’s culture. The various business units and
trading desks are responsible for ensuring that market risk exposures are well-managed and prudent. The control
groups help ensure that these risks are measured and closely monitored and are made transparent to senior
management. The Market Risk Department is responsible for ensuring transparency of material market risks,
monitoring compliance with established limits, and escalating risk concentrations to appropriate senior
management. To execute these responsibilities, the Market Risk Department monitors the Company’s risk
against limits on aggregate risk exposures, performs a variety of risk analyses, routinely reports risk summaries,
and maintains the Company’s VaR system. Limits are designed to control price and market liquidity risk. Market
risk is monitored through various measures: statistically (using VaR and related analytical measures); by
measures of position sensitivity; and through routine stress testing and scenario analyses conducted by the
Market Risk Department in collaboration with the business units. The material risks identified by these processes
are summarized in reports produced by the Market Risk Department that are circulated to and discussed with
senior management, the Risk Committee and the Board.
Risk and Capital Management Initiatives.
During 2009, the Company continued to enhance its market risk management framework to address the severe
stresses observed in global markets during the recent economic downturn (see “Executive Summary—Global
Market and Economic Conditions in Fiscal 2009” Part II, Item 7, herein). The Company expanded and improved
its risk measurement processes, including stress tests and scenario analysis, and refined its market risk limit
framework. In conjunction with these risk measurement enhancements, a proprietary methodology called Stress
VaR (“S-VaR”) was developed to comprehensively measure the Company’s market and credit risks. S-VaR
simulates many stress scenarios based on more than 25 years of historical data and attempts to capture the
different liquidities of various types of general and specific risks, as well as event and default risks particularly
relevant for credit portfolios. S-VaR, while still evolving, is becoming an important metric for the Company’s
risk appetite assessment and its capital allocation framework.
Sales and Trading and Related Activities.
Primary Market Risk Exposures and Market Risk Management. During 2009, the Company had exposures to
a wide range of interest rates, equity prices, foreign exchange rates and commodity prices—and the associated
implied volatilities and spreads—related to the global markets in which it conducts its trading activities.
The Company is exposed to interest rate and credit spread risk as a result of its market-making activities and other
trading in interest rate sensitive financial instruments (e.g., risk arising from changes in the level or implied
volatility of interest rates, the timing of mortgage prepayments, the shape of the yield curve and credit spreads). The
activities from which those exposures arise and the markets in which the Company is active include, but are not
limited to, the following: emerging market corporate and government debt, non-investment grade and distressed
corporate debt, investment grade corporate debt and asset-backed debt (including mortgage-related securities).
The Company is exposed to equity price and implied volatility risk as a result of making markets in equity
securities and derivatives and maintaining other positions (including positions in non-public entities). Positions in
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