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CFA Level I · CFA Level I Exam · Introduction to Geopolitics

A portfolio manager notes that a regional conflict has increased the probability of a supply disruption in an energy-exporting region. Which of the following portfolio responses is most likely consistent with managing this risk through diversification and hedging?

Holding assets whose returns are weakly correlated with the conflict's effects is most consistent with managing the risk. Such diversification limits the portfolio's sensitivity to a single geopolitical shock, whereas concentrating or adding exposure in the affected region would raise vulnerability to the same event.

  1. AConcentrating holdings in energy importers in the same region
  2. BHolding assets whose returns are weakly correlated with the conflict's effectsCorrect
  3. CRaising exposure to the region's equities to capture the higher premium

Explanation

Diversification reduces exposure to a shared shock by holding assets whose returns respond differently to the event. Concentrating in the same region, or adding exposure, increases the vulnerability to the same geopolitical shock.

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