FRM Part II · FRM Exam Part II · Case Study: Financial Crime and Fraud
An investment adviser reports steady monthly returns to clients using funds from new investors to pay redemptions to earlier investors, while no genuine trading occurs. Which statement best characterizes the structure and its key vulnerability?
This is a Ponzi scheme, which fails when new investor inflows no longer cover redemptions. Returns are paid from fresh capital rather than genuine trading profits, so the structure depends on continuous growth in deposits and collapses once withdrawals exceed new money.
- AA Ponzi scheme that collapses when new inflows fall short of redemption demandsCorrect
- BA pump-and-dump scheme that collapses when the share price falls
- CA front-running scheme that ends when regulators change trading rules
- DA kiting scheme that ends when the bank clears the checks
Explanation
Paying earlier investors with money from later investors without real investment is the defining feature of a Ponzi scheme, and it fails when inflows cannot cover redemptions. Pump-and-dump involves manipulating a traded security price, front-running exploits client order knowledge, and kiting uses float between accounts.
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