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FRM Part II · FRM Exam Part II · Managing Nondeposit Liabilities

A bank issues a $200 million brokered CD at a stated rate of 4.00% annually. The broker is paid an upfront fee of 0.50% of principal, and the CD matures in two years with a single principal repayment. Using the simple approximation of spreading the fee evenly over the term, what is the approximate all-in annual cost of funds?

The approximate all-in cost is 4.25%. The 0.50% upfront broker fee is spread over two years, adding 0.25% per year to the 4.00% coupon. Ignoring the fee understates cost, and treating the full fee as annual overstates it.

  1. A4.50%
  2. B4.25%Correct
  3. C3.75%
  4. D4.00%

Explanation

The fee is 0.50% of principal over a 2-year term, so it adds 0.25% per year. The all-in cost is 4.00% + 0.25% = 4.25%. Ignoring the fee gives 4.00%. Using 0.50% per year gives 4.50%, which fails to amortize the fee over the term. Subtracting the fee gives 3.75%, the wrong sign.

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