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Answer: A matched-maturity marginal cost of funds approach converts the bank's fixed-rate borrowing cost to a floating-rate borrowing cost.
C is correct. A matched-maturity marginal cost of funds liquidity pricing policy converts the bank's fixed rate borrowing cost to floating and equals the spread above a reference rate. This approach is designed to more accurately reflect the cost of funds for the bank, taking into account the specific maturities of the assets and liabilities involved. By matching the maturity of the assets and liabilities, the bank can better manage its liquidity and interest rate risk. The other options provided are incorrect for the following reasons: A is incorrect because a zero-cost liquidity pricing policy would actually result in the bank holding long-term highly illiquid assets funded by short-term liabilities, which can create liquidity and interest rate risk. B is incorrect because it is the zero-cost of funds liquidity pricing policy that tends to result in the greatest maturity transformation for a bank's balance sheet, not the average cost of funds approach. D is incorrect because neither a zero-cost of funds approach nor an average cost of funds approach will appropriately align the maturity of the bank's lending and borrowing activities when management compensation is based on net income. This is because management may structure a significant maturity mismatch between assets and liabilities in order to increase net income, which can lead to financial instability.
Author: LeetQuiz Editorial Team
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A bank's treasurer is currently examining different methodologies for pricing liquidity and is concerned about the potential impacts associated with each method. To address these concerns, the treasurer has tasked an analyst with the responsibility of investigating and evaluating the various approaches used for pricing the transfer of liquidity. The analyst is expected to analyze these methods thoroughly and prepare a comprehensive report that includes well-founded recommendations.
A
A zero-cost of funds approach tends to result in the bank holding long-term highly illiquid assets funded by long-term stable liabilities
B
An average cost of funds approach tends to result in the greatest maturity transformation for a bank's balance sheet.
C
A matched-maturity marginal cost of funds approach converts the bank's fixed-rate borrowing cost to a floating-rate borrowing cost.
D
Both an average cost of funds approach and a zero-cost of funds approach appropriately align the maturity of the bank's lending and borrowing activities when management compensation is based on net income.
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