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

At Allfirst Financial (subsidiary of Allied Irish Banks), John Rusnak concealed foreign exchange trading losses by booking fictitious options. Which feature of these fictitious options most directly helped him avoid detection by the back office?

Rusnak booked fictitious offsetting options that made his positions look hedged and lowered apparent risk. Because the back office did not confirm the trades with counterparties and the trades never settled in cash, the fake hedges went unchallenged, hiding real losses for years.

  1. AThey were booked as offsetting positions that appeared to hedge his risk, with no cash settlement being confirmedCorrect
  2. BThey were traded on an exchange with daily margin calls, exposing losses immediately
  3. CThey were recorded as long-dated bonds that paid coupons monthly
  4. DThey were reported directly to the regulator, which approved them

Explanation

Rusnak entered bogus options that made his book look hedged and reduced apparent VaR. Back-office staff failed to confirm them with counterparties, since the trades were fictitious and no cash flows actually settled. Exchange-traded products would have shown margin calls, so option B is wrong.

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