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

A bank estimates that, without controls, expected annual fraud loss on a product is USD 4.0 million. A preventive control reduces the probability of fraud events by 60% with no change in severity. A detective control then catches 50% of the remaining loss early enough to recover it fully. Residual expected loss after both controls is closest to:

Residual expected loss is USD 0.8 million. Prevention cuts USD 4.0 million to USD 1.6 million, and the detective control recovers half of what remains, leaving USD 0.8 million. The controls act in sequence, so their effects multiply rather than add.

  1. AUSD 0.8 millionCorrect
  2. BUSD 1.6 million
  3. CUSD 0.4 million
  4. DUSD 1.2 million

Explanation

After prevention: 4.0 x (1 - 0.60) = 1.6 million. The detective control recovers 50% of that: 1.6 x 0.5 = 0.8 million. Check: 4.0 x 0.4 x 0.5 = 0.8. The 1.6 figure ignores the detective control; adding the effects as 110% is invalid.

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