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

A bank's matched-funding LTP curve gives a 5-year term liquidity premium of 80 bp over the base rate. A business unit originates a 5-year loan at 4.60% with a base rate of 3.20%. Treasury must also charge a contingent liquidity cost of 15 bp for an undrawn commitment line attached to the loan. Ignoring credit and operating costs, what is the unit's liquidity-adjusted margin?

The liquidity-adjusted margin is 0.45%. The loan earns 1.40% over the base rate, and subtracting the 0.80% term liquidity premium and the 0.15% contingent liquidity charge for the undrawn commitment leaves 0.45%.

  1. A0.45%Correct
  2. B0.60%
  3. C1.40%
  4. D0.25%

Explanation

Gross spread over base = 4.60% - 3.20% = 1.40%. Deduct the term liquidity premium 0.80% and the contingent cost 0.15%: 1.40 - 0.80 - 0.15 = 0.45%. Omitting the contingent charge gives 0.60%, the key distractor.

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