LM05 Introduction to Geopolitics 2024 Level I Notes

LM05 Introduction to Geopolitics

1. Introduction ...........................................................................................................................................................3
2. National Governments and Political Cooperation ..................................................................................3
Features of Political Cooperation .................................................................................................................3
Motivations for Cooperation ..........................................................................................................................4
Resource Endowment, Standardization, and Soft Power ...................................................................4
The Role of Institutions ....................................................................................................................................5
Hierarchy of Interests and Costs of Cooperation ...................................................................................6
Power of the Decision Maker .........................................................................................................................6
Political Non-Cooperation ...............................................................................................................................6
3. Forces of Globalization ......................................................................................................................................6
Features of Globalization .................................................................................................................................6
Motivations for Globalization ........................................................................................................................7
Costs of Globalization and Threats of Rollback .......................................................................................7
4. International Trade Organizations ...............................................................................................................8
International Monetary Fund.........................................................................................................................8
World Bank Group ..............................................................................................................................................8
World Trade Organization ..............................................................................................................................9
5. Assessing Geopolitical Actors and Risk .......................................................................................................9
Autarky ................................................................................................................................................................ 10
Hegemony ........................................................................................................................................................... 11
Multilateralism ................................................................................................................................................. 11
Bilateralism ........................................................................................................................................................ 11
6. The Tools of Geopolitics ................................................................................................................................. 12
National Security Tools ................................................................................................................................. 12
Economic Tools ................................................................................................................................................ 13
Financial Tools .................................................................................................................................................. 13
Multifaceted Approaches .............................................................................................................................. 14
Geopolitical Risk and Comparative Advantage .................................................................................... 14
7. Geopolitical Risk and the Investment Process ...................................................................................... 14
Types of Geopolitical Risk ............................................................................................................................ 14
Assessing Geopolitical Threats ................................................................................................................... 15
Tracking Risks According to Signposts ................................................................................................... 15
Manifestations of Geopolitical Risk .......................................................................................................... 16
Acting on Geopolitical Risk .......................................................................................................................... 16

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LM05 Introduction to Geopolitics 2024 Level I Notes

Summary ...................................................................................................................................................................17

This document should be read in conjunction with the corresponding learning module in the 2024
Level I CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures are
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LM05 Introduction to Geopolitics 2024 Level I Notes

1. Introduction
Geopolitics is the study of how geography affects politics and international relations. Under
geopolitics, analysts study actors—the individuals, organizations, companies, and national
governments that engage in political, economic, and financial activities—and how they
interact with one another.
Geopolitical risk is the risk associated with tensions or actions between actors that affect
the normal and peaceful course of international relations. Geopolitical risk could arise due to
a change in policy, a natural disaster, a terrorist act, a theft, or war.
Investors study geopolitical risk because it can have a tangible impact on investment
outcomes. This learning module provides a framework by which investors can measure,
assess, track, and react to geopolitical risk, in order to improve investment outcomes.
2. National Governments and Political Cooperation
Actors can be split into two types:
• State actors: National governments, political organizations, or country leaders that exert
authority over a country’s national security and resources. For example, South African
President, Malaysia’s Parliament, and the British Prime Minister.
• Non-state actors: Entities that participate in global political, economic, or financial
affairs but do not directly control national security or country resources. For example,
NGOs, multinational companies, charities, and even influential individuals such as
business leaders and cultural icons.
Features of Political Cooperation
At the highest level, the relationship between state actors can be cooperative or competitive.
Cooperation is the process by which countries work together toward some shared goal or
purpose. These goals may vary widely from strategic or military concerns to economic
influence or cultural preferences.
One specific type of cooperation – political cooperation – refers to the extent to which
countries work toward agreements on rules and standardization for the activities and
interactions with one another. We can classify countries as cooperative countries and non-
cooperative countries.
• Cooperative country: A country that engages and reciprocates in rule standardization;
tariff harmonization; international agreements on trade, immigration, or regulation; and
allows free flow of information, including technology transfer.
• Non-cooperative country: A country with inconsistent and even arbitrary rules;
restricted movement of goods, services, people, and capital across borders; retaliation;
and limited technology exchange.

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LM05 Introduction to Geopolitics 2024 Level I Notes

Motivations for Cooperation

There are many reasons why a country may want to cooperate with its neighbors or with
other state actors. These reasons are typically defined by a country’s national interest.
National Security or Military Interest
National security (also known as national defense) is the protection of a country, its citizens,
economy, and institutions from external threats. These threats can range from military
attacks to terrorism, crime, cyber-security, and even natural disasters.
Geographic factors influence a country's approach to national security and the extent to
which it will choose a cooperative approach.
• Landlocked countries, such as Switzerland, rely heavily on their neighbors for access to
vital resources. Because of this reliance, cooperation is important for sustaining
international access and growth, or even for survival.
• Countries that are well-connected to trade routes, such as Singapore, or countries acting
as a conduit for trade, such as Panama, may use their geographic location as a lever of
power.
Economic Interest
The concept of national security has evolved over time to include economic factors such as
access to resources like energy, food, and water. Countries that choose to cooperate in
support of their economic interests are most likely interested in one of two things: either
securing essential resources through trade or levelling the global playing field for their
companies or industries through standardization.
Resource Endowment, Standardization, and Soft Power
Geophysical Resource Endowment
Geophysical resource endowment includes factors such as livable geography and climate, as
well as access to food and water, all of which are required for sustainable growth.
Geophysical resource endowment varies greatly among countries. Some countries (e.g.
Unites States) are relatively self-sufficient in their resource use. While some countries (e.g.
Japan) rely heavily on others for key factors of production, such as fossil fuels. These
differences create power dynamics that can influence the terms of engagement between
states.
Standardization
Standardization is the process of creating protocols for the production, sale, transport, or use
of a product or service. Standardization can aid in the expansion of economic and financial
activities across borders, benefiting all parties who agree to follow these protocols together.
The different types of rules standardization are: regulatory cooperation, process

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LM05 Introduction to Geopolitics 2024 Level I Notes

standardization, and operational synchronization. Exhibit 2 from the curriculum provides

examples for each type.
Regulatory Process Operational
Cooperation Standardization Synchronization
Challenge As financial cooperation Financial transactions Increasing international
expands, countries need across borders faced trade created supply
a comprehensive higher costs and longer chain bottlenecks as
standard for governance wait times, increasing containers of different
and risk management of the burden for cross- sizes and shapes were
the banking sector. border activity. sent to ports worldwide.
Solution Basel Committee on Society for Worldwide Containerization
Banking Supervision Interbank Financial
(BCBS) Telecommunication
(SWIFT)
Process The BCBS was SWIFT was established Standards set for
established in 1974 by in 1973 to provide a containers of uniform
the G10 banking global financial size and shape using
authorities. Membership infrastructure. multi-modal forms of
has since expanded to transport (land, sea, air,
the G20 rail) and port cranes.
Benefit Allows for more Facilitates global Dramatically reduces
effective supervision of payments in more than the time and cost of
the global banking 200 countries and shipping goods.
sector and international territories, servicing
capital flows. more than 11,000
institutions worldwide.
Cultural Considerations and “Soft Power”
Some countries may cooperate with others for cultural reasons such as: long-standing
political ties, immigration patterns, shared experiences, or cultural similarities.
Some countries may engage in soft power – which is a means of influencing another
country’s decisions without force or coercion. Soft power can be built over time through
actions such as cultural programs, advertisement, travel grants, and university exchange. For
example, South Korea promotes visiting Seoul (its capital) in subway systems around the
world. These advertisements use popular Korean-made products, musical acts, and actors to
encourage interaction with Korean culture and business.
The Role of Institutions
An institution is an established organization or practice in a society or culture. An institution
can be a formal structure, such as a university, organization, or process backed by law; or, it

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LM05 Introduction to Geopolitics 2024 Level I Notes

can be informal, such as customs or behavioral patterns important to a society.

Strong institutions generally contribute to more stable internal and external political forces.
This stability provides a country more opportunity to develop cooperative relationships.
Stronger institutions also make cooperative relationships more durable.
Hierarchy of Interests and Costs of Cooperation
A country’s national interest can be thought of as a hierarchy of factors. Those essential for
survival are at the top and nice-but-not-essential elements are lower down.
Governments use the hierarchy of interests to guide their behavior. They will choose to
cooperate where it benefits the nation-state, but when two needs result in conflicting
cooperation tactics, those higher up the hierarchy take precedence. For example, two
countries engaged in a military conflict may not cooperate on tariff harmonization, even
though tariff harmonization may benefit both countries on a stand-alone basis.
Power of the Decision Maker
The length of a country’s political cycle can influence its hierarchy of national interests.
Many countries have political cycles of only a few years, making it difficult to prioritize long-
term risks such as climate change or addressing income inequality over projects or goals
that can be accomplished in a short period of time.
Decision makers, such as political parties or individuals, may have their own set of
influences or needs, which can affect a country's cooperative and non-cooperative choices.
Political Non-Cooperation
Political cooperation and non-cooperation exist on a spectrum. While it is in some countries’
interest to be highly politically cooperative, for others it is less essential. There are some
cases of extreme non-cooperation—countries whose political autonomy is more important
than the benefits of any cooperative actions.
3. Forces of Globalization
Globalization is the process of interaction and integration among people, companies, and
governments worldwide. It has led to the spread of products, information, jobs, and culture
across borders.
Features of Globalization
Globalization is primarily carried out by non-state actors, such as corporations, individuals,
or organizations, and is the result of economic and financial cooperation.
Globalization is marked by economic and financial cooperation, including the active trade of
goods and services, capital flows, currency exchange, and cultural and information exchange.
By contrast, anti-globalization or nationalism is the promotion of a country’s own economic
interests to the exclusion or detriment of the interests of other nations. Nationalism is

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LM05 Introduction to Geopolitics 2024 Level I Notes

marked by limited economic and financial cooperation.

Motivations for Globalization
Globalization provides the following potential gains to non-state actors (such as companies
and investors):
• Increased profits: Profits can be increased by increasing sales. Globalization allows
companies to access new customers for their goods and services thereby increasing
sales.
Another way to boost profits is to reduce costs. Globalization allows companies to access
lower-tax operating environments, reduce labor costs, and seek other supply chain
efficiency gains, all of which are cost-reduction measures.
• Access to resources and markets: Companies need sustainable access to resources
such as talent or raw materials. If these resources are not readily available or affordable
in their home country, then companies may globalize to improve access.
Some investors may seek investment opportunities in foreign markets. In this context,
there are two important types of flows. Portfolio investment flows are short-term
investments in foreign assets, such as stocks or bonds. Alternatively, foreign direct
investments (FDI) are long-term investments in the productive capacity of a foreign
country.
• Intrinsic gain: Intrinsic gain is a side effect or consequence of an activity that generates
a benefit beyond profit itself. One example of intrinsic gain is the personal growth or
education that people can obtain by broadening their horizons, visiting new places, or
learning new ideas.
Costs of Globalization and Threats of Rollback
Globalization also has some potential disadvantages, such as:
• Unequal accrual of economic and financial gains: Although globalization generally
improves aggregate economic activity, this does not imply improvement for everyone.
For example, if a company relocates a factory to another country, it creates jobs in the
new country but reduces jobs in the home country.
• Lower ESG standards: Companies that operate in lower-cost countries often adhere to
the local standards of those countries. If the ESG standards in one country are lower as
compared to another, and companies follow the lower standards, then globalization can
create a drain on human, administrative, and environmental resources.
• Political consequences: The two costs listed above can lead to a third cost of
globalization: the political consequences of global expansion. While some countries may
benefit from increased labor force utilization, others may lose jobs as companies

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LM05 Introduction to Geopolitics 2024 Level I Notes

relocate. Therefore, globalization has the potential to exacerbate income and wealth
inequality, as well as differences in opportunity within and between countries.
• Interdependence: Due to globalization companies may become dependent on other
countries’ resources for their supply chains. If there is a disruption to the supply chain, as
witnessed in the COVID-19 pandemic, then companies may not be able to produce the
good themselves.
4. International Trade Organizations
International Monetary Fund
Primary responsibilities of the IMF: To ensure the stability of the international monetary
system, the system of exchange rates, and international payments that enables countries to
buy goods and services from each other.
• Provides a forum for cooperation on international monetary problems.
• Facilitates the growth of international trade and promotes employment, economic
growth, and poverty reduction.
• Supports exchange rate stability and an open system of international payments.
• Lends foreign exchange to members when needed, on a temporary basis and under
adequate safeguards, to help them address balance of payments problems.
How does the IMF ensure global economic stability?
• Financial assistance: The IMF stands ready to lend foreign currencies to member
countries to assist them during periods of significant external deficits. A pool of gold
and currencies contributed by members provides the IMF with the resources
required for these lending operations. Following the 2007-09 crisis, the IMF has
enhanced its lending facilities and member countries’ access to fund resources.
• Surveillance: In the wake of several financial crises in the recent past (downgrading
of Greek sovereign debt to non-investment grade and its cascading effects on other
EMU countries such as Italy, Spain, etc.), the IMF has improved its monitoring of
global, regional, and country economies on macroeconomic policies.
• Helping resolve global economic imbalances.
• Technical assistance: Offers training to country officials on how to design and
implement effective macroeconomic policies, and how to manage their financial
systems and capital markets.
World Bank Group
The World Bank’s main objective is to help developing countries fight poverty and enhance
environmentally sound economic growth. One of the current goals of the World Bank to
achieve by 2030 is to end extreme poverty by decreasing the percentage of people living on
less than $1.25 a day to less than 3%. (Source: worldbank.org)

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LM05 Introduction to Geopolitics 2024 Level I Notes

The World Bank funds projects in developing countries and provides financial and technical
expertise with an objective to reduce poverty. It finances these projects through its two
affiliated entities, IBRD and IDA. Both these organizations provide low or no interest loans to
countries that have unfavorable or no access to international credit markets.
• The International Bank for Reconstruction and Development (IBRD): The
primary source of funding for the bank is by selling AAA- rated bonds in the world’s
financial markets. It has enjoyed this high rating since 1959. IBRD’s reserves have
been built up over the years with the capital contributed by the bank’s 188 member
countries. It generates income from lending out its own capital. IBRD’s income pays
for the World Bank’s operating expenses.
The International Development Association (IDA): The world’s largest source of interest-
free loans and grant assistance to the poorest countries.
World Trade Organization
The WTO is the only organization that deals with the rules of trade between nations. The
most important functions of the WTO include:
• Implementation, administration, and operation of individual agreements. All the
major decisions are taken by the representatives of the governments who meet
regularly in Geneva.
• Acting as a platform for negotiations such as lowering customs tariffs, removing trade
barriers, etc.
• Settling disputes: If the countries feel there has been an infringement of an
agreement, or any other dispute, then the issue is settled by the WTO.
• Building trade capacity: The WTO helps developing countries to build the skills and
infrastructure needed to boost their trade.
• WTO agreements have been signed by a large majority of the world’s trading nations
and ratified in their respective parliaments.
• The WTO has the mandate to review and propagate its members’ trade policies and
ensure the coherence and transparency of trade policies through surveillance in a
global policy setting.
5. Assessing Geopolitical Actors and Risk
Geopolitical actors can be classified into four categories based on two axes – ‘political
cooperation versus non-cooperation’ and ‘globalization versus nationalism’. Exhibit 7 from
the curriculum illustrates this classification.

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LM05 Introduction to Geopolitics 2024 Level I Notes

The four categories are: autarky, hegemony, multilateralism, and bilateralism. Each category
has its own costs, benefits, and tradeoffs with respect to geopolitical risk.
In general terms, regions, countries, and industries that are more reliant on on cross-border
goods and capital flows will have higher levels of cooperation.
The interdependent nature of globalization may reduce the likelihood that collaborative
countries levy economic, financial, or political attacks on one another. However, that same
interdependence can make cooperative actors more vulnerable to geopolitical risk than
those less dependent on cooperation and trade.
For geopolitical risk analysis, it is important to consider not only which quadrant a country
currently occupies, but also its stability within that quadrant. A hegemon working to
strengthen political cooperation may pose less of a threat to investment outcomes than a
multilateral actor attempting to undermine them.
Autarky
Autarky refers to countries that seek political self-sufficiency with little or no external trade
or finance. Strategic domestic industries are controlled by state-owned enterprises. The self-
sufficiency of autarkic countries allows them to be stronger politically. They are able to
exercise complete control over the supply of technology, goods and services, as well as
media and political messaging.
In some cases, autarky can allow a country to achieve rapid economic and political
development. For example, during much of the 20th century China acted as an autarkic.
During this period, China was able to reduce poverty significantly and has since moved
towards more economic and financial cooperation.
However, in other cases, such as North Korea and Venezuela, autarky has resulted in a
gradual loss of economic and political development within the country.

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LM05 Introduction to Geopolitics 2024 Level I Notes

Hegemony
Hegemonic countries tend to be regional or even global leaders, who use their political or
economic influence over others to control resources.
A hegemonic system can benefit both the hegemonic countries themselves and the
international system. The economic and political dominance of a hegemon may provide it the
ability to significantly influence global affairs. Countries that follow the hegemon's rules and
standards may reap the benefits provided by the leader, including the stabilizing force of
monitoring and enforcing the hegemon's standards.
However, hegemonic systems also have costs. Hegemons may become more competitive as
they gain or lose influence, increasing the likelihood of geopolitical risk.
Example of hegemonic countries include the United States and Russia.
Multilateralism
Multilateralism refers to countries that participate in mutually beneficial trade relationships
and extensive rule harmonization. Private firms are fully integrated into global supply chains
with multiple trade partners.
Examples of multilateral countries include Germany and Singapore. Factors that have led
Singapore to rely heavily on globalization to achieve economic success are:
• Factor endowment: Singapore has limited natural resources, including water and arable
land. This makes it highly dependent on trade partners and innovation to survive.
• Geographic location: Singapore is located at the intersection of many important global
trade routes which helps make it an Asian center for world business.
• Cultural factors: Singapore’s population is highly ethnically and racially diverse, fluent in
English and highly skilled.
• Institutional factors: Singapore has highly stable political institutions with high
governmental priorities on promoting economic activity and enforcing business-friendly
institutional governance. This makes it a preferred investment destination and an
attractive trade partner.
Bilateralism
Bilateralism is the conduct of political, economic, financial, or cultural cooperation between
two countries. Countries that engage in bilateralism may have relations with many different
countries, but these are one-at-a-time agreements without multiple partners.
Countries typically exist on a spectrum between bilateralism and multilateralism. Between
the two extremes is regionalism, which involves a group of countries collaborating with one
another. For example, regional blocs may agree to provide trade benefits to one another
while raising barriers for those outside the group.

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LM05 Introduction to Geopolitics 2024 Level I Notes

Japan once fit the description of bilateralism perfectly. Its government engaged in significant
political cooperation in order to develop a strong export market, but it did not globalize its
imports. However, today Japan would be considered a multilateral player.
6. The Tools of Geopolitics
Geopolitical tools can be classified into three types:
• National security tools
• Economic tools
• Financial tools
As discussed in Sec 5, geopolitical risk analysts must monitor not only which quadrant best
describes an actor, but also its stability within that quadrant. The use of various national
security, economic, or financial tools may indicate that an actor's character is changing,
which may increase or decrease geopolitical risk. Exhibit 9 from the curriculum depicts how
geopolitical tools fit into the four archetypes of country behavior.

National Security Tools

National security tools are those used to influence or coerce a state actor through direct or
indirect impact on the country’s resources, people, or borders. National security tools may
be active (in use at the time of analysis), or threatened (likely to be used in near future).
Armed conflict is the most extreme example of a national security tool. It is a direct and
active national security tool that can have two major consequences:
• Destruction of physical infrastructure, which can have a long-term impact on a
country's capital stock and ability to rebuild that stock.
• Migration away from areas of armed conflict, which has the potential to alter
international flows of goods, services, capital, and labor. It may also impact
neighboring countries and states that accept refugees.

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LM05 Introduction to Geopolitics 2024 Level I Notes

Not all national security tools used are as direct in nature as armed conflict. For example,
espionage (the practice of using spies to obtain political or military information) is an
indirect national security tool. Another example is miliary alliances which are frequently
used to either aid in direct conflict or to prevent conflict from occurring in the first place.
Also, not all national security tools are necessarily used in a non-cooperative way. For
example, the North Atlantic Treaty Organization (NATO), an alliance between the European
Union, United States, United Kingdom, and Canada which was originally constructed to
provide collective security against the Soviet Union, is now used to discuss and de-escalate
potential conflict among members and between members and outside states.
Economic Tools
Economic tools are the actions used to reinforce cooperative or non-cooperative stances via
economic means.
Examples of cooperative economic tools include multilateral trade agreements (such as
Southern Common Market - MERCOSUR, which facilitates trade among member countries in
South America) and the global harmonization of tariff rules (as facilitated by the World Trade
Organization, WTO).
Examples of non-cooperative economic tools include nationalism (the process of transferring
an activity or industry from private to state control), voluntary export restraints (refusing to
trade as much of their goods and services as would meet demand), and imposing domestic
content requirement (stating that a certain proportion of domestic input be included in an
exported good.)
Financial Tools
Financial tools are the actions used to reinforce cooperative or non-cooperative stances via
financial mechanisms.
Examples of cooperative financial tools include the free exchange of currencies across
borders and allowing foreign investment.
Examples of non-cooperative financial tools include limiting access to local currency markets
and restricting foreign investment.
Cooperative financial tools that encourage cooperation in security, economic, and financial
arenas may reduce geopolitical risk. However, if the system becomes too dependent on a
particular financial tool, it may introduce vulnerabilities in the international system that can
have far-reaching consequences. For example, transactions in the international interbank
market are heavily denominated in US dollars. While the market itself represents a form of
cooperation, over reliance on the US dollar makes other countries vulnerable to changes in
the US monetary policy.

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LM05 Introduction to Geopolitics 2024 Level I Notes

Multifaceted Approaches
The national security, economic, and financial geopolitical tools discussed above can be
intertwined. An example is cabotage which refers to the right to transport passengers or
goods within a country by a foreign firm. Many countries, including those with multilateral
trade agreements, impose cabotage restrictions across transportation subsectors. This
means that shippers, airlines, and truck drivers are not permitted to transport goods and
services within the borders of another country. Allowing cabotage requires multilateral
coordination in areas such as physical security and economic coordination.
Geopolitical Risk and Comparative Advantage
Geopolitical risk and tools of geopolitics can affect the comparative advantage of a country.
Countries with low geopolitical risk may attract more labor and capital. Whereas, countries
with high geopolitical risk may suffer a loss of labor and capital. For instance, Germany’s
reaction to the Syrian refugee crisis is an example of comparative advantage stemming from
geopolitical risk. Germany was able to resettle one million Syrian refugees due to its strong
economic position in the EU and long-standing political stability. By adding young and
talented migrants, Germany’s long-term demographic balance has improved which can
potentially increase its economic growth rate.
7. Geopolitical Risk and the Investment Process
The degree to which investors consider geopolitical risk in their decision-making will vary
widely depending on their investment objectives and risk tolerance. Some investors may not
consider geopolitical risk separately, whereas others may make geopolitical risk a central
component of their investment strategy.
Types of Geopolitical Risk
The three basic types of geopolitical risk are:
• Event risk: Event risk evolves around set dates, such as elections, new legislation, or
other date-driven milestones, such as holidays or political anniversaries, known in
advance. Political events often cause investors to change their expectations about a
country’s cooperative stance. Brexit is an example of event risk.
• Exogenous risk: Exogenous risk is a sudden or unanticipated risk that impacts either a
country’s cooperative stance, the ability of non-state actors to globalize, or both.
Examples include sudden uprisings, invasions, or the aftermath of natural disasters.
• Thematic risk: Thematic risks are known risks that evolve and expand over a period of
time. Examples include climate change, cyber threats, and the ongoing threat of
terrorism.

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LM05 Introduction to Geopolitics 2024 Level I Notes

Assessing Geopolitical Threats

To assess geopolitical threats, an investor considers geopolitical risk in terms of the
following three areas:
• Likelihood it will occur: Refers to the probability that a risk will occur. Measuring the
likelihood is a challenging process and this exercise can be more art than science.
• Velocity (speed) of its impact: Refers to the pace at which a risk may impact an
investor’s portfolio. Impacts can be classified into:
o Short-term or high velocity impacts: Exogeneous or ‘black swan’ (an event that is
rare and difficult to predict but has a significant impact) events fit this category.
Such events cause market volatility and investor flight to quality in the short term.
But long-term changes may not be required.
o Medium-term impacts: Risks with medium term impact may affect a company’s
process, costs, and investment opportunities, resulting in lower valuations. These
risks tend to impact some companies/sectors more than others.
o Long-term or low velocity impacts: Long-term risks may have significant ESG
impacts requiring an adjustment to an investor’s long term asset allocation.
However, they may have limited immediate impact on portfolios.
• Size and nature of that impact: A risk’s impact on a portfolio can manifest in many
different ways. Generally, investors are more concerned with risks that have a high-
impact and may ignore risks that have a low-impact.
Also, the size of a risk’s impact can be magnified by external factors. For example, risk
tends to have a greater impact on markets experiencing an economic downturn.
Impacts may be discrete (affecting only one company/sector) or broad (affecting the
entire economy) in nature. For example, cyber risks can have both discrete and broad
impacts. In the event of a cyberattack, the specific company will be impacted. It will also
impact all other companies by increasing their monitoring, due diligence, and security
costs.
Geopolitical risks rarely evolve in a linear fashion, which makes it difficult to forecast their
likelihood, velocity, size and nature of impact on a portfolio. Therefore, instead of using a
single point forecast, many investors use a scenario building and signposting approach.
Scenario analysis is the process of comparing portfolio outcomes across different scenarios
or states of the world. Scenarios can be qualitative, quantitative, or a combination of the two.
Tracking Risks According to Signposts
A signpost is an indicator, market level, data piece, or event that signals a risk is becoming
more or less likely. We can think of signposts like a traffic light.

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LM05 Introduction to Geopolitics 2024 Level I Notes

• If the risk is low in likelihood, velocity, or impact then the signposts are flashing
‘green’ indicating ‘no action needed’.
• If the risk is medium in likelihood, velocity, or impact then the signposts are flashing
‘amber’ indicating ‘higher caution and preparedness’.
• If the risk further rises in likelihood, velocity or impact then the signposts are flashing
‘red’ indicating ‘an action plan is necessary’.
Consider the ‘Brexit’ example. Before 2014, the signposts for geopolitical risk in the UK may
have flashed green. When the referendum was announced in 2015, the signposts flashed
amber. In May 2016, when phone polls suggested that the “leave” vote was gaining majority,
the signposts flashed red.
Manifestations of Geopolitical Risk
High-velocity risks are most likely to manifest themselves in market volatility through
sudden changes in asset prices. For example, in response to the COVID-19 pandemic, the S&P
500 index declined nearly 34%. Also, investors flight to safety pushed up US bond prices and
the US 10-year treasury yield declined by nearly 68%. Note, however that this impact was
not permanent and the markets eventually recovered.
Low-velocity geopolitical risks can have a more prolonged impact. Sustained disruption can
lead to lower revenues, higher costs, or both, all of which can have a negative impact on a
company's valuation.
Investors may require higher compensation for countries, regions, or sectors perceived to be
at higher risk of geopolitical disruption, effectively increasing the discount rate investors use
when valuing those securities. This is a key reason why investors demand a higher required
return for investments in emerging and frontier markets as compared to developed markets.
Acting on Geopolitical Risk
On a macroeconomic level, geopolitical risks can impact capital market conditions, such as
economic growth rates, interest rates, and market volatility. This in turn can influence the
asset allocation decisions of investors.
Geopolitical risks can also influence the amount of capital an investor allocates to different
countries. For example, more capital will be allocated to countries with a long history of
using a multilateral approach and less capital will be allocated to countries experiencing
consistent military threat.
On a portfolio level, investors can consider geopolitical risk as one of the factors in a multi-
factor model. Geopolitical risk can influence the appropriateness of an investment security
or strategy for an investor’s goals, risk tolerance, and time horizon. For example, an investor
with low risk tolerance should reduce exposure to geopolitical risk through low-volatility
investment choices or through hedging.

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LM05 Introduction to Geopolitics 2024 Level I Notes

Summary
LO. Describe geopolitics from a cooperation versus competition perspective.
Geopolitics is the study of how geography affects politics and international relations. Under
geopolitics, analysts study actors—the individuals, organizations, companies, and national
governments that engage in political, economic, and financial activities—and how they
interact with one another.
Political cooperation refers to the extent to which countries work toward agreements on
rules and standardization for the activities and interactions with one another. We can
classify countries as cooperative countries and non-cooperative countries.
• Cooperative country: A country that engages and reciprocates in rule standardization;
tariff harmonization; international agreements on trade, immigration, or regulation;
and allows free flow of information, including technology transfer.
• Non-cooperative country: A country with inconsistent and even arbitrary rules;
restricted movement of goods, services, people, and capital across borders;
retaliation; and limited technology exchange.
Political cooperation and non-cooperation exist on a spectrum. While it is in some countries’
interest to be highly politically cooperative, for others it is less essential.
LO. Describe geopolitics and its relationship with globalization.
Globalization is primarily carried out by non-state actors, such as corporations, individuals,
or organizations.
Globalization is marked by economic and financial cooperation, including the active trade of
goods and services, capital flows, currency exchange, and cultural and information exchange.
By contrast, anti-globalization or nationalism is the promotion of a country’s own economic
interests to the exclusion or detriment of the interests of other nations. Nationalism is
marked by limited economic and financial cooperation.
Geopolitical actors can be classified into four categories based on two axes – ‘political
cooperation versus non-cooperation’ and ‘globalization versus nationalism’. The four
categories are: autarky, hegemony, multilateralism, and bilateralism. Each category has its
own costs, benefits, and tradeoffs with respect to geopolitical risk.
LO: Describe functions and objectives of the international organizations that facilitate
trade, including the World Bank, the International Monetary Fund, and the World
Trade Organization.
International Monetary Fund:
• International monetary cooperation and exchange rate stability.
• Assists in setting up international payments systems; makes resources available to
member countries with balance of payments problems.

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LM05 Introduction to Geopolitics 2024 Level I Notes

World Bank:
• Low-interest loans, interest-free credits, and grants to developing countries for many
specific purposes.
• Provides resources and knowledge and helps form private/public partnerships with
the overall aim of fighting poverty.
World Trade Organization:
• Ensures that trade flows freely and works smoothly.
• Main focus: Institute, interpret, and enforce a number of multilateral trade
agreements which detail global trade policies for a large majority of the world’s
trading nations.
LO: Describe geopolitical risk.
The three basic types of geopolitical risk are:
• Event risk: Evolves around set dates known in advance.
• Exogenous risk: A sudden or unanticipated risk that impacts either a country’s
cooperative stance, the ability of non-state actors to globalize, or both.
• Thematic risk: Known risks that evolve and expand over a period of time.
LO. Describe tools of geopolitics and their impact on regions and economies.
Geopolitical tools can be classified into three types:
• National security tools: e.g., armed conflict, espionage, military alliances
• Economic tools: e.g., multilateral trade agreements, global harmonization of tariff
rules
• Financial tools: e.g., exchange of currencies across borders, foreign investments
Geopolitical tools can be used in both a cooperative or non-cooperative way.
LO. Describe the impact of geopolitical risk on investments.
Investors study geopolitical risk because it has a tangible impact on investment outcomes.
To assess geopolitical threats, an investor considers geopolitical risk in terms of the
following three areas:
• Likelihood it will occur
• Velocity (speed) of its impact
• Size and nature of that impact
Geopolitical risks rarely evolve in a linear fashion, which makes it difficult to forecast their
likelihood, velocity, size and nature of impact on a portfolio. Therefore, instead of using a
single point forecast, many investors use a scenario building and signposting approach.

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