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

A bank's funding curve gives a term liquidity premium of 40 bps for 1-year funding and 100 bps for 5-year funding. A business unit gathers a term deposit with a contractual maturity of 5 years that is non-withdrawable before maturity. Under good LTP practice, what credit should treasury give the unit for this liability?

The unit should be credited about 100 bps, the 5-year liquidity premium. Because the deposit cannot be withdrawn before maturity, it provides genuine 5-year stable funding, and good LTP credits liabilities at the term funding rate matching their effective tenor.

  1. A40 bps, because the deposit is retail
  2. BAbout 100 bps, because the stable 5-year funding is worth the 5-year liquidity premiumCorrect
  3. CZero, because liabilities should not receive credit
  4. D70 bps, the average of the two points, regardless of tenor

Explanation

Liabilities supplying stable term funding should be credited at the term funding rate matching their effective tenor. A non-withdrawable 5-year deposit therefore earns the 5-year premium of 100 bps. Using the 1-year point undervalues the funding, and averaging ignores the tenor.

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