FRM Part II · FRM Exam Part II · Madoff: A Riot of Red Flags
An analyst reviewing a hedge fund feeder notes that it reports steady monthly returns of about 1% with almost no down months, attributed to a 'split-strike conversion' strategy, yet the manager gives no transparency into positions. Which feature of the Madoff scheme does this pattern most closely resemble?
The pattern resembles Madoff's implausibly smooth returns from a split-strike conversion strategy, which should have shown market sensitivity, combined with secrecy about positions. Such consistency with no transparency is a classic red flag of fabricated returns.
- AReturns that were implausibly smooth relative to the stated equity-and-options strategy, combined with opacity about tradingCorrect
- BReturns that were highly volatile and correlated with the equity market
- CReturns driven by high leverage disclosed to all investors
- DReturns produced by an independent, audited prime broker with full position reporting
Explanation
Madoff reported consistently smooth, low-volatility returns from a strategy that should have shown equity-market sensitivity, while keeping trading details opaque. This mismatch is a core red flag. The other options describe features that were absent from the scheme.
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