Skip to content

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

In the 2012 JPMorgan 'London Whale' episode, the Chief Investment Office's synthetic credit portfolio losses were made worse by a change to the VaR model. Which description best captures the governance failure?

The failure was weak model governance: a new VaR model, inadequately validated and prone to spreadsheet errors, understated risk and masked limit breaches in the synthetic credit portfolio. Limits existed but were undermined by the flawed model and weak oversight, not by absent limits or hidden accounts.

  1. AA new VaR model was adopted that understated risk, was poorly vetted and had spreadsheet-based errors, so limit breaches were maskedCorrect
  2. BThe bank lacked any VaR limit and so did not monitor the portfolio
  3. CRegulators prohibited the bank from hedging credit exposure
  4. DTraders used unauthorized accounts to hide positions from the exchange

Explanation

The new model, implemented with weak validation and manual spreadsheet errors, lowered reported VaR and reduced the apparent limit breaches. Limits did exist and were breached, and there was no hidden-account fraud, so the other options are inaccurate.

Did you get it right without looking?

One question tells you little. A timed set on Learning From Financial Disasters shows your real accuracy, how long you take and where you lose marks.

Practise Learning From Financial DisastersFree diagnostic mock

More Learning From Financial Disasters questions