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

Under good-practice LTP, which feature most appropriately addresses the cost of holding a liquidity buffer of high-quality liquid assets (HQLA) against contingent outflows such as undrawn credit lines?

The contingent liquidity cost of the HQLA buffer, meaning its net carry cost, should be charged to the business units that grant commitments such as undrawn credit lines, because they create the potential outflows. Leaving it with treasury or ignoring off-balance-sheet items leaves that liquidity risk unpriced.

  1. ACharging the business units that grant the commitments a contingent liquidity cost reflecting the net carry cost of the bufferCorrect
  2. BCharging the cost only to the treasury department, since it holds the assets
  3. CIgnoring the buffer cost because undrawn commitments are off-balance sheet
  4. DCrediting the units granting commitments for the yield on the HQLA

Explanation

Best practice allocates contingent liquidity costs, including the negative carry of holding the buffer, to the businesses whose off-balance-sheet exposures create the need. Keeping it in treasury hides the cost, and ignoring off-balance-sheet items leaves the risk unpriced.

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