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

An analyst uses the chapter's finding that elevated geopolitical risk is linked to lower equity returns and wider sovereign spreads, with stronger effects in some countries. For an emerging market portfolio, which country feature would the analyst expect to be associated with a larger adverse asset price response to a rise in geopolitical risk?

Countries with weaker macro-financial fundamentals and higher initial sovereign risk are expected to show larger adverse asset price responses. They have fewer buffers, so investors demand more compensation when geopolitical risk rises, whereas reserves, strong institutions, a stable investor base and low financing needs dampen the reaction.

  1. AWeaker macro-financial fundamentals and a higher starting level of sovereign riskCorrect
  2. BLarger holdings of foreign exchange reserves and strong institutions
  3. CA deep, stable domestic institutional investor base
  4. DLow external financing needs and low debt

Explanation

Countries with weaker fundamentals and higher sovereign risk have less buffer, so investors demand more compensation when geopolitical risk rises. The other options describe buffers that dampen the response.

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