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

A desk marks a USD 200 million illiquid bond position using a model price of 98.0 per 100. Dealer quotes available only after a market shock are 92.0 per 100 bid. The firm's policy is to mark to the most reliable exit price. The desk's model price is later shown to have used stale spread inputs. What is the valuation loss the firm should recognise by moving from model to bid mark, and which valuation failure does this exemplify?

The loss is (98 minus 92) divided by 100 times USD 200 million, which equals USD 12 million. This exemplifies a valuation failure where stale model inputs replaced observable exit prices, overstating asset values until a market shock revealed the gap between model and executable prices.

  1. AUSD 12 million; reliance on stale model inputs instead of observable exit pricesCorrect
  2. BUSD 6 million; reliance on stale model inputs instead of observable exit prices
  3. CUSD 12 million; excessive use of mark-to-market accounting
  4. DUSD 16 million; failure to hedge interest rate risk

Explanation

Loss = (98.0 - 92.0)/100 x 200 million = 6% x 200 million = USD 12 million. The failure is mark-to-model using stale inputs rather than observable exit prices. USD 6 million results from using the 6 points as a percent of 100 million, the wrong base.

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