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Explanation:
To calculate the charge for funding liquidity risk using the matched-maturity marginal cost of funds approach, we need to look at the term liquidity premium for the corresponding maturity of the loan. In this case, we're dealing with a one-year non-amortizing bullet loan, so we'll focus on the one-year term.
Let's calculate this for both the pre-crisis and current scenarios:
Pre-Global Financial Crisis:
For a one-year loan:
Term liquidity premium = 1 basis point
So, the charge for funding liquidity risk = 1 basis point
Current:
For a one-year loan:
Term liquidity premium = 5 basis points
So, the charge for funding liquidity risk = 5 basis points
Therefore:
We can observe that the charge for funding liquidity risk has increased significantly from the pre-crisis period to the current period, reflecting the increased perception of liquidity risk in the banking system.
Q.4206 Assume the following term liquidity premiums and the average cost of funds were recorded by a bank at a point before the crisis (Pre-GFC), and more recently.
Pre-GFC and Current Term Liquidity Premiums and Average Cost of Funds
| Term in years | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|
| Pre-Global Financial Crisis | |||||
| Term liquidity premium | 1 | 3 | 5 | 7 | 10 |
| Average cost of funds | 3 | 3 | 3 | 3 | 3 |
| Current | |||||
| Term liquidity premium | 5 | 8 | 10 | 18 | 35 |
| Average cost of funds | 10 | 10 | 10 | 10 | 10 |
Using the matched-maturity marginal cost of funds approach, calculate the amount of charge that a one-year non-amortizing bullet loan will be charged for funding liquidity risk if it originated pre-crisis and more recently, respectively.
A
$1 and $3
B
$1 and $5
C
$3 and $5
D
$10 and $35
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