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

A rogue trader's true position has a 1-day 99% VaR of USD 40 million. He books fictitious offsetting trades that make the reported position appear to have a VaR equal to 5% of the true figure. Management has a VaR limit of USD 3 million. Which conclusion is correct?

Reported VaR is 5% of USD 40 million, or USD 2 million, which is inside the USD 3 million limit. The true VaR of USD 40 million exceeds the limit by USD 37 million, showing that VaR limits fail when position data are falsified.

  1. AReported VaR is USD 2 million, within the limit, while true VaR exceeds the limit by USD 37 millionCorrect
  2. BReported VaR is USD 2 million, which breaches the limit by USD 1 million
  3. CReported VaR is USD 20 million, which breaches the limit
  4. DReported VaR is USD 2 million, and true VaR is within the limit

Explanation

Reported VaR = 5% x 40 = USD 2 million, below the USD 3 million limit. True VaR of USD 40 million exceeds the limit by 40 - 3 = USD 37 million. Hence limits based on reported figures give false comfort when the underlying records are falsified.

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