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Implementation of a Funds Transfer Pricing model with stochastic interest rates

Danielsson, Fredrik (2014) FMS820 20142
Mathematical Statistics
Abstract (Swedish)
The subject of Funds Transfer Pricing (FTP) is widely known within the banking in-
dustry, despite this there is a lack of consensus on how to allocate the costs and benets
to the users and suppliers of liquidity. A common practice in nancial institutions, in
particular before the nancial crisis, was to charge business units a liquidity charge that
was based on the average or the historic cost of funds, which did not properly re
ect the
liquidity risk for each specic business unit. Today practitioners are introducing more
rigorous FTP approaches to better allocate the cost/benet of liquidity arising products
to business units11.
The aim of this thesis is to implement and further develop a theoretical FTP model which
will seek to,... (More)
The subject of Funds Transfer Pricing (FTP) is widely known within the banking in-
dustry, despite this there is a lack of consensus on how to allocate the costs and benets
to the users and suppliers of liquidity. A common practice in nancial institutions, in
particular before the nancial crisis, was to charge business units a liquidity charge that
was based on the average or the historic cost of funds, which did not properly re
ect the
liquidity risk for each specic business unit. Today practitioners are introducing more
rigorous FTP approaches to better allocate the cost/benet of liquidity arising products
to business units11.
The aim of this thesis is to implement and further develop a theoretical FTP model which
will seek to, in as detailed manner as possible, transfer the liquidity costs/benets arising
from nancial products back to the originator. This will result in a more transparent view
of the liquidity costs/benets associated with an institutions assets and liabilities and
thus enhance its ability to take more informed decisions regarding the actual protability
of the products.
The focus will also be to model a benchmark rate which will serve as a proxy for the
risk-free interest rate, which is one of the key underlying components in the total cost of
funding, using a stochastic interest rate model. By examining the relationship between
the FTP rate, the total cost of funding and the risk-free interest rate one is able to use the
interest rate model together with interest rate scenarios to make predictions for future
FTP rates and funding costs. The information provided by the simulation together with
the scenarios can be an input for strategic funding decisions for the institution, e.g.
how much is the expected cost of funding for a certain project under dierent scenarios
looking two years ahead?
Incorporating this information when considering future business opportunities can help
banks in assessing the risk when measuring the protability of future funding agreements
due to the uncertainty in the funding costs. (Less)
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author
Danielsson, Fredrik
supervisor
organization
course
FMS820 20142
year
type
H2 - Master's Degree (Two Years)
subject
language
English
id
4697158
date added to LUP
2014-10-14 10:10:58
date last changed
2014-10-14 10:10:58
@misc{4697158,
  abstract     = {The subject of Funds Transfer Pricing (FTP) is widely known within the banking in-
dustry, despite this there is a lack of consensus on how to allocate the costs and benets
to the users and suppliers of liquidity. A common practice in nancial institutions, in
particular before the nancial crisis, was to charge business units a liquidity charge that
was based on the average or the historic cost of funds, which did not properly re
ect the
liquidity risk for each specic business unit. Today practitioners are introducing more
rigorous FTP approaches to better allocate the cost/benet of liquidity arising products
to business units11.
The aim of this thesis is to implement and further develop a theoretical FTP model which
will seek to, in as detailed manner as possible, transfer the liquidity costs/benets arising
from nancial products back to the originator. This will result in a more transparent view
of the liquidity costs/benets associated with an institutions assets and liabilities and
thus enhance its ability to take more informed decisions regarding the actual protability
of the products.
The focus will also be to model a benchmark rate which will serve as a proxy for the
risk-free interest rate, which is one of the key underlying components in the total cost of
funding, using a stochastic interest rate model. By examining the relationship between
the FTP rate, the total cost of funding and the risk-free interest rate one is able to use the
interest rate model together with interest rate scenarios to make predictions for future
FTP rates and funding costs. The information provided by the simulation together with
the scenarios can be an input for strategic funding decisions for the institution, e.g.
how much is the expected cost of funding for a certain project under dierent scenarios
looking two years ahead?
Incorporating this information when considering future business opportunities can help
banks in assessing the risk when measuring the protability of future funding agreements
due to the uncertainty in the funding costs.},
  author       = {Danielsson, Fredrik},
  language     = {eng},
  note         = {Student Paper},
  title        = {Implementation of a Funds Transfer Pricing model with stochastic interest rates},
  year         = {2014},
}