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

A bank's treasury operates a liquidity transfer pricing (LTP) framework. A business unit originates a 5-year fixed-rate corporate loan that is fully funded at origination. Which approach best reflects sound LTP practice for charging the liquidity cost of this loan?

The loan should be charged a liquidity cost based on its behavioral or contractual term, using a term funding curve. This matches the transfer price to the tenor of liquidity consumed, whereas overnight or pooled average rates misstate the true cost and distort business incentives.

  1. ACharge a single overnight funding rate regardless of the loan's tenor
  2. BCharge a rate based on the loan's behavioral or contractual term, so that the funding cost reflects the term of the liquidity the loan consumesCorrect
  3. CCharge the bank's average cost of funds across all liabilities
  4. DCharge no liquidity cost because the loan is already funded at origination

Explanation

Sound LTP matches the transfer charge to the tenor of the liquidity the asset consumes, using a term funding curve. An overnight rate understates the cost of a long loan, and a pooled average rate hides differences between products and tenors and distorts incentives.

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