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

A bank grants a corporate client an undrawn committed credit line of 200 million. The treasury estimates that, in a stress scenario, 40% will be drawn within 30 days. The stressed 30-day funding spread over the base rate is 1.50% annualized, and the bank charges the business unit a contingent liquidity premium on the expected stressed draw. Which annual charge is consistent with this approach, ignoring any probability of the stress occurring?

The charge is 1.2 million. The stressed draw is 40% of 200 million, or 80 million, and funding that amount costs 1.50% annually, giving 1.2 million. Charging on the full commitment would overstate the cost, since only the expected drawn portion needs funding in stress.

  1. A3.0 million, being 200 million x 1.50%
  2. B1.2 million, being 80 million x 1.50%Correct
  3. C0.8 million, being 80 million x 1.00%
  4. D4.8 million, being 200 million x 40% x 6%

Explanation

Expected stressed draw is 200 x 40% = 80 million. Applying the 1.50% stressed spread gives 80 x 0.015 = 1.2 million. Charging on the full 200 million ignores the drawdown assumption, and the other options use unsupported rates.

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