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FRM Part II · FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

A risk manager at a global asset manager reviews a sudden rise in geopolitical tension that is expected to affect emerging market economies. Which portfolio flow pattern is most consistent with the way geopolitical risk shocks typically transmit through investor behavior to emerging market funds?

Geopolitical shocks usually cause risk-off behavior, so investors pull money from emerging market bond and equity funds. The resulting outflows tighten financial conditions in those economies. The other patterns assume that the shock is priced in or ignored, which does not fit observed investor behavior.

  1. ALarger outflows from emerging market bond and equity funds as investors reduce risk exposureCorrect
  2. BStable inflows because geopolitical events are fully priced in advance
  3. CInflows into local currency bonds as investors seek higher yield
  4. DNo change in flows because passive funds do not react to news

Explanation

Heightened geopolitical risk typically raises risk aversion and prompts investors to withdraw from riskier cross-border assets, so emerging market funds see outflows. The inflow options ignore the risk-off response. Passive funds also experience redemptions when their investors sell.

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