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

A bank's internal fraud analysis of a past unauthorized-trading event finds: (1) the trader's limit breaches were reclassified as 'temporary' by his manager, (2) offsetting fictitious hedge trades were booked with a cancellation before settlement, and (3) cash settlement of those trades never occurred. Which detective control would have been most likely to uncover the scheme earliest?

Reconciling trade-level cash and margin flows to the booked positions, and investigating cancelled or unsettled trades, is the most effective detective control. Fictitious hedges generate no real settlement or counterparty confirmation, so independent reconciliation reveals them quickly.

  1. AReconciliation of trade-level cash and margin flows to the front-office position record, with investigation of cancelled or unsettled tradesCorrect
  2. BQuarterly review of the trader's performance appraisals
  3. CAnnual review of the code of conduct
  4. DComparison of daily P&L against the prior year's P&L

Explanation

Fictitious hedges are identifiable because they generate no actual cash, margin or counterparty confirmation. Independent reconciliation of settlement and margin flows to booked positions, with scrutiny of cancelled trades, directly exposes this. Appraisals, code reviews and year-on-year P&L comparisons do not test the existence of trades.

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