Which risk pertains to sudden changes in market direction affecting interest rates and equities?

The risk that relates to sudden changes in market direction affecting interest rates and equities is market risk. Market risk is the risk of losses in positions arising from movements in market prices. It encompasses changes in interest rates, equity prices, commodity prices, and foreign exchange rates. Such fluctuations can directly impact the values of investments in equities and fixed-income securities, leading to potential losses or gains depending on the market movements.

The concepts of first-order and second-order risk refer to the sensitivity and reactions of financial instruments to market changes rather than defining the risk itself. First-order risk is typically associated with the immediate effects of market movements, while second-order risk reflects the volatility and uncertainty arising from those changes over time. Liquidity risk, on the other hand, pertains to the difficulty in buying or selling assets without affecting their price, which is separate from the impact of market direction changes.

Understanding market risk is crucial for investors and financial professionals, as it helps in formulating strategies to mitigate potential losses due to market volatility and ensuring that an investment portfolio is aligned with the investor's risk tolerance.