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

A bank uses matched-maturity LTP. A business unit originates a $100 million 4-year loan. The bank's funding curve is 3.0% for 1 year, 3.4% for 4 years and the bank adds a 0.30% liquidity premium for contingent liquidity costs on committed lines that the unit also sells. The loan yields 5.0% and has expected credit loss of 0.50% and operating costs of 0.40% annually. Charging the 4-year rate only (excluding the premium), what is the unit's annual net margin, and how does it change if the 0.30% premium is also charged?

Net margin is 5.0% minus the 3.4% four-year transfer rate, 0.5% expected loss and 0.4% operating cost, giving 0.70%. Charging the additional 0.30% liquidity premium lowers it to 0.40%, showing how LTP exposes the true cost of contingent liquidity.

  1. A0.70% excluding the premium; 0.40% after the premiumCorrect
  2. B1.10% excluding the premium; 0.80% after the premium
  3. C0.30% excluding the premium; 0.00% after the premium
  4. D1.60% excluding the premium; 1.30% after the premium

Explanation

Margin = 5.0% − 3.4% − 0.5% − 0.4% = 0.70%. Charging the extra 0.30% premium reduces it to 0.40%. The 1.10% option omits one cost, while 1.60% uses the 3.0% 1-year rate and ignores costs; 0.30% wrongly deducts both credit and funding twice.

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