Question 66

An increase in international stocks and a decrease in corporate bonds in a portfolio will increase political risk.

Investing in international stocks exposes a portfolio to various geopolitical factors, including political instability, regulatory changes, and economic shifts in foreign countries. As corporate bonds decrease, the relative impact of these external factors on the portfolio's overall risk profile increases.

A) Credit

Credit risk pertains to the possibility of a borrower defaulting on a loan or bond. While investing in international stocks may have some implications for credit risk, the primary concern with the given changes in the portfolio is related to external political factors rather than the creditworthiness of issuers.

B) Political

Political risk is heightened when investing in international markets, as foreign investments are subject to the political climate of the countries in which they are made. Changes in government, civil unrest, and shifts in policy can all affect the performance of international stocks, making this the correct choice in the context of the portfolio adjustments described.

C) Interest rate

Interest rate risk involves changes in interest rates that affect the value of bonds and fixed-income investments. In this scenario, a decrease in corporate bonds does not directly correlate to an increase in interest rate risk; rather, it suggests a shift away from fixed-income securities, which is not the primary concern highlighted.

D) Reinvestment

Reinvestment risk occurs when an investor is unable to reinvest cash flows from investments at the same rate of return as the original investment. While this is a relevant risk in fixed-income securities, it does not directly relate to the increase in international stocks, making it less pertinent in this context.

Conclusion

Political risk is the most relevant type of risk associated with an increase in international stocks and a decrease in corporate bonds. Other risks such as credit, interest rate, and reinvestment do not adequately capture the implications of exposure to foreign investments, particularly given the potential for political instability and changes in foreign markets. Thus, political risk is definitively the correct answer in this scenario.