What does sovereign risk involve?

Sovereign risk primarily refers to the risk that a government may default on its debt obligations. This encompasses the potential inability or unwillingness of a government to meet its repayment commitments, which can arise from various factors such as economic downturns, political instability, or unfavorable changes in economic policies. When investors purchase government bonds, they are essentially trusting the government to honor its debts, and if a default occurs, it can lead to significant financial losses for those holding such investments.

Other options reflect important risks but do not encapsulate the essence of sovereign risk. For example, while government policies influencing investment values is a concern, it falls more under policy risk or regulatory risk rather than sovereign risk specifically. Similarly, risks associated with international currency exchanges relate to foreign exchange risk, which is distinct from sovereign risk as it deals more with currency valuation than debt obligations. Lastly, compliance with international laws pertains to legal risk and regulatory frameworks, which, while relevant, does not define sovereign risk either. Thus, the correct choice captures the crux of the concept of sovereign risk effectively.