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

A bank prices a 5-year fixed-rate bullet loan using a matched-maturity transfer rate. The 5-year risk-free swap rate is 3.00% and the bank's 5-year term liquidity premium is 0.80%. The loan carries a customer rate of 4.50%. What is the loan's net interest spread after the transfer charge?

The net spread is 0.70%. The matched-maturity transfer rate is the 3.00% swap rate plus the 0.80% liquidity premium, giving 3.80%. Subtracting this from the 4.50% customer rate leaves 0.70%, whereas ignoring the liquidity premium would overstate profitability at 1.50%.

  1. A0.70%Correct
  2. B1.50%
  3. C3.70%
  4. D0.00%

Explanation

Transfer rate = 3.00% + 0.80% = 3.80%. Spread = 4.50% − 3.80% = 0.70%. The 1.50% option omits the liquidity premium. The 3.70% option mistakenly adds the premium to the customer rate before subtracting.

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