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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

A bank's trading desk of 20 traders earns a bonus equal to 10% of annual profit with no clawback and no deduction for losses. Which risk-management conclusion is most consistent with lessons from financial disasters?

The structure encourages excessive risk taking. Traders share in gains but not losses, with no clawback, giving an option-like payoff that rewards larger bets while the firm and shareholders bear the downside, a recurring lesson from financial disasters.

  1. AThe structure aligns trader interests with shareholders because pay is tied to profit
  2. BThe structure encourages excessive risk taking because gains are shared asymmetrically while losses are borne by the firmCorrect
  3. CThe structure reduces operational risk by limiting the number of traders
  4. DThe structure is appropriate provided VaR is reported monthly

Explanation

Participation in profits without sharing losses creates an option-like payoff, rewarding larger risk. Reporting VaR monthly does not fix the incentive problem, and the arrangement does not align with shareholders who bear the downside.

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