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FRM Part II · FRM Exam Part II · Liquidity Transfer Pricing: A Guide to Better Practice

A bank constructs its liquidity transfer pricing curve by taking the risk-free curve and adding its own term funding spread. Spreads over the risk-free curve are 20 bp at 1 year, 50 bp at 3 years and 80 bp at 5 years. The risk-free rates are 2.00%, 2.60% and 3.00% respectively. A 4-year amortising loan has a weighted-average life of 3 years under the matched-funding principle, and the bank interpolates nothing beyond using the 3-year point. Treasury also charges a 10 bp contingent liquidity buffer cost on undrawn commitments only. The loan is fully drawn. What transfer rate applies?

The transfer rate is 3.10%. An amortising loan is matched to its weighted-average life of 3 years, so the 2.60% risk-free rate plus the 0.50% funding spread applies. The 10 bp buffer cost relates only to undrawn commitments and does not apply because the loan is fully drawn.

  1. A3.10%Correct
  2. B3.20%
  3. C2.80%
  4. D3.00%

Explanation

Matching on weighted-average life of 3 years gives risk-free 2.60% + spread 0.50% = 3.10%. The buffer charge applies only to undrawn commitments, so it is excluded. The 3.20% option wrongly adds it; 2.80% uses the 1-year spread; 3.00% uses the 5-year risk-free rate without spread.

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