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FRM Part II · FRM Exam Part II · Madoff: A Riot of Red Flags

A Ponzi scheme reports 1,200 million of client assets and has real cash of 300 million. Redemption requests arrive from clients with 240 million of reported balances in a stress period, and no new inflows occur. Assuming redemptions are paid in full from cash, what is the cash coverage ratio of the remaining reported liabilities after the payments?

Coverage falls to about 6.25%. Paying 240 million leaves 60 million of cash against 960 million of remaining reported client balances. Both numerator and denominator must be adjusted for the redemptions, which shows how quickly a Ponzi scheme becomes unable to meet further withdrawals.

  1. A300 − 240 = 60 cash against 960 reported liabilities, about 6.25%Correct
  2. B300 against 1,200, 25%
  3. C60 against 1,200, 5%
  4. D300 against 960, about 31.25%

Explanation

After paying 240, cash is 60 and reported liabilities are 1,200 − 240 = 960. Coverage is 60/960 = 6.25%. Using unadjusted cash or unadjusted liabilities mismatches the base.

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