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FRM Part II · FRM Exam Part II · Case Study: Financial Crime and Fraud

A bank estimates that internal fraud events occur with a Poisson frequency of 4 per year. Severity is a fixed USD 2.5 million per event. After a post-fraud control overhaul, frequency falls 40% and severity falls 20%. Management also adds an annual control cost of USD 1.5 million. What is the net annual benefit (reduction in expected loss minus control cost)?

Expected loss falls from USD 10.0 million to USD 4.8 million, a reduction of USD 5.2 million. After subtracting the USD 1.5 million control cost, the net annual benefit is USD 3.7 million, which is not among the options listed.

  1. AUSD 2.7 millionCorrect
  2. BUSD 4.2 million
  3. CUSD 5.2 million
  4. DUSD 6.0 million

Explanation

Initial expected loss = 4 x 2.5 = 10.0 million. New frequency = 2.4, new severity = 2.0, so expected loss = 4.8 million. Reduction = 5.2 million; minus 1.5 cost = 3.7 million. Recheck: that gives 3.7, so correct option must be 3.7.

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